PROPERTY PAYS FOR ITS OWNER: REVERSE MORTAGAGE.. Getting into old age without proper financial support can be a very bad experience. No regular incomes, with rising cost of living can make life tough; the ideal solution would be a constant inflow of income, without any work. In 2007, the finance minister of India introduced a concept well-known and widely accepted in the West: Reverse Mortgage. MEANING: A reverse mortgage (or lifetime mortgage) is a loan available to senior citizens. Reverse mortgage, as its name suggests, is exactly opposite of a typical mortgage, such as a home loan. It is a financial instrument that allows a senior citizen who owns a home to consume some of his housing equity by converting it into an income stream, yet maintain ownership and residence in the home. ORIGIN AND INTENT OF THE LAWMAKER: The reverse mortgage scheme offered by some of the leading banks in India brought the required answers to the suffering senior citizens. Most of the senior citizens either by inheritance or by virtue, own property in their names, but they were not able to convert it into instant and regular income stream due to its illiquid nature. The Union Budget 2007-2008 had a great proposal which introduced the Reverse Mortgage' scheme. The concept is simple, a senior citizen who holds a house or property, but lacks a regular source of income can put mortgage his property and get regular income. WORKING: In a typical mortgage, you borrow money in lump sum right at the beginning and then pay it back over a period of time using Equated Monthly Instalments (EMIs). In reverse mortgage, you mortgage a property with a bank or housing finance company (HFC) you already own (with no existing loan outstanding against it). The bank, in turn, gives you a series of cash-flows for a fixed tenure. These can be thought of as reverse EMIs. The person who reverse mortgages' his property can stay in the house for his life and continue to receive the much needed regular payments. So, effectively the property now pays for the owner. The catch is that the bank has the right to sell the property in case the owner wishes to leave the place or dies.
FEATURES: The draft guidelines of reverse mortgage in India prepared by the Reserve Bank of India having the features elaborated below: a) Any house owner over 60 years of age is eligible for a reverse mortgage. b) The maximum loan is up to 60 per cent of the value of the residential property. Loan to value ratio means the percentage of loan that you will get for the value of the property that you pledge. The typical rate loan to value ratio is 60 per cent. So, for e.g., if you pledge a property worth Rs 60 lakh (Rs 6 million), then the loan amount that you can get is Rs 36 lakh (Rs 3.6 million). c) The maximum period of property mortgage is 15 years with a bank or HFC (housing finance company). d) The borrower can opt for a monthly, quarterly, annual or lump sum payments at any point, as per his discretion. e) The revaluation of the property has to be undertaken by the bank or HFC once every 5 years. f) The amount received through reverse mortgage is considered as loan and not income; hence the same will not attract any tax liability. g) Reverse mortgage rates can be fixed or floating and hence will vary according to market conditions depending on the interest rate regime chosen by the borrower.
LOAN REPAYEMENT: With a reverse home mortgage, no payments are made during the life of the borrower(s). Since no payments are made during the term of the reverse home mortgage loan, the loan balance rises over time. In most areas where appreciation is good, the value of the home grows at a much faster rate than the loan balance. Therefore, the remaining equity continues to grow. When the last borrower passes, or it is decided to sell the home and move, the loan becomes due. The ownership of the home is then passed to the estate or directed by a living will or will to the beneficiaries. The beneficiaries now own the home and have to sell the home or pay off the loan. If the home is sold, the reverse home mortgage lender is paid off and any excess amount will be remitted back to the borrower or his heirs. Capital gains shall be attracted on such sale and the legal heir is liable to pay the computed taxes. ELIGIBLE LOAN AMOUNT: The reverse mortgage loan amount cannot be used for speculative, trading purposes such as shares etc. It may be used for supplementing income for the purpose of daily personal and family consumption, medical costs, house improvement and maintenance, payment of property tax and insurance. It can also be used for repaying a previous loan on the property to be mortgaged. TAXATION ASPECT: Finance Act, 2008 exclude the transfer of capital asset as per section 2(47) of the Income tax Act in a transaction of reverse mortgage to give relief to the senior citizens who mortgaged property for their survival. Further, Finance Act, 2008 also clarifies that the amount received as loan shall not be treated an income and would be exempt from tax in the hands of the senior citizen under section 10(43). Although, loan is a capital receipt, but to clarify the position of the senior citizen and promote the scheme of reverse mortgage, it has been provided that such income shall be exempt from tax in the hands of the senior citizen.
For Example: Mr. A (Father) acquired a house property for Rs.10 Lakhs and took a loan from bank under the reverse mortgage loan scheme. The outstanding loan, including the interest their on was 65 Lakhs. Their can be three possibilities and mentioned below are the tax treatment for the same: CASE-1 CASE-2 CASE-3 Father Mr. A repays the loan of 65L to the bank and sells the HP @ 100 Lakhs CAPITAL GAIN FOR FATHER Selling price= 100Lakhs COA=10 Lakhs -------------------------------------- Capital gain tax on 90Lakhs V.S.M.R Jagdish CHandran Vs C.I.T (Supreme Court) 1997 Father Mr. A dies and son repays the loan of Rs.65 L and sells the HP @ 100 Lakhs CAPITAL GAIN FOR SON Selling price= 100Lakhs COA=10 Lakhs Cost of Improvement=65Lakhs --------------------------------------- -- Capital gain tax on 25Lakhs RM. Arunachalam v. CIT (Supreme Court) 1997 Father Mr.A dies and son doe not repays the loan of Rs.65 L, bank sells the HP @ 100 Lakhs CAPITAL GAIN FOR SON Selling price= 100Lakhs COA=10 Lakhs ------------------------------- ---- Capital gain tax on 25Lakhs And bank will return Rs.35 Lakhs to the son RM. Arunachalam v. CIT (Supreme Court) 1997 The supreme court held that Under section 49(1), where the assessee acquires a property from the previous owner in inheritance, then the cost of acquisition to the assessee is the cost to the previous owner as increased by cost of improvement incurred by the assessee and the previous owner. In a mortgage there is a transfer of interest in the property by the mortgagor in favour of the mortgagee. When the previous owner had mortgaged the property, then after his death the legal heir inherent the mortgagor s interest in the property. By discharging the mortgage debt heir who has inherent the property acquires the interest of mortgagee in the property. As a result of such payment made for clearing of the mortgage the interest of the mortgagee is acquired by the heir. The said payment is therefore as regarded as cost of acquisition. Therefore, the cost of acquisition to the legal heir is the aggregate of the cost to the previous owner and amount paid to clear the mortgage.
V.S.M.R Jagdish CHandran Vs C.I.T (Supreme Court) 1997 The Supreme court turned down the Argument of the assessee and held that the amount paid by the son to clear mortgage debt cannot be said to be the cost of acquisition or cost of improvement of the property. This was not the case where the property has been acquired from the previous owner as was the case in RM. Arunachalam v. CIT. Since in the present case the mortgage was created by the assessee himself, there will be no tax treatment of discharge of mortgage debt and the same cannot be said to be the cost of acquisition or cost of improvement of the property. NO QUESTION REMAINS UNANSWERED: What happens when one of the partners dies/ when both die? If one of the spouses dies, the other can still continue living in the house. If both die, the bank will give their heirs two options -- settle the overall outstanding loan and retain the house, or the bank will sell the house, use the proceeds to settle the outstanding loan and give the rest to the heirs. What are the interest rates? The banks have so far not indicated the interest rates. However, we can safely assume that it will not exceed the interest rates used for loan against property Does the age of the mortgager matters? The homemakers age does effect the annuity payments. Higher the age, higher the annuity! Who will be responsible for payment of taxes etc. and the maintenance of the property? The borrower will insure the house against all natural calamities. The borrower will also ensure to pay all taxes, electricity charges, water charges and other statutory payments pertaining to the house. The borrower will maintain the house in good condition. What are the various events of default under Reverse Mortagage? It is liable for foreclosure owing to the occurrence of the following events of default: If the borrower has not stayed in the property for a continuous period of one year. If the borrower has not stayed in the property for a continuous period of one year.
If the borrower fails to pay property taxes or maintain and repair the residential property or fails to keep the home insured, the PLI reserves the right to insist on repayment of loan by bringing the residential property to sale and utilizing the proceeds to meet the outstanding balance of principal and interest. If the borrower declares bankruptcy. If the residential property so mortgaged to the PLI is donated or abandoned by the borrower. If the borrower effects changes in the residential property that affect the security of the loan for the lender. For example: renting out part or all of the house; adding a new owner to the property's title; changing the property's zoning classification; or creating further encumbrance on the property either by way of taking out new debt against it or alienating the interest by way of a gift or will. Owning to perpetration of fraud or misrepresentation by the borrower. If the government under statutory provisions, seeks to acquire the residential property for public use. If the government condemns the residential property (for example, for health or safety reasons). Will Power of attorney holder of a property be eligible for loan? No. The property should be self-acquired, self-occupied and having clear title in favour of the borrower. Whether there is any minimum period of ownership of property before availing of Reverse Mortgage? No. There is no minimum period of ownership of property required. Whether a property in a Cooperative Housing Society eligible under Reverse mortgage? Yes. The property should have a clear title and be mortgagable to the lender. What are the advantages of an RML? The main advantages are: Income Supplement: Enables house-owning Senior Citizens having inadequate income to meet their financial needs for renovation/repairs to house, medical &
other personal purposes. Retaining ownership: The borrower continues to retain ownership of the house. Social Security: In the absence of social security for Senior Citizens, RML serves as a partial substitute. No Repayments: A borrower does not have to repay a RML during his or her lifetime or till such time he or she continues to stay in the house. Freedom and Flexibility: Amount availed under a RML may be utilized for any purpose other than investing in shares, real estate, trading etc. How is an RML different from other Mortgage Loans? Criteria Conventional Mortgage (housing loan) Loan against Residential Property (Home Equity loan) Reverse Mortgage Loan Purpose of loan To purchase/ upgrade a house To get cash from a residential asset for a variety of personal purposes To get cash from a residential asset for a variety of purposes including home improvement, repairs and personal purposes Eligible borrowers Creditworthy borrowers Creditworthy borrowers who have clear title to a house property Senior Citizens who have clear title to a house where they reside permanently At time of beginning of loan Borrower has no equity in the house Borrower has substantial equity in the house Borrower has substantial equity During the loan tenure, the borrower Makes monthly repayments to the lender Loan balance goes down Makes monthly repayments to the lender Loan balance goes down Receives payments from the lender Loan balance rises Equity
Borrower's equity grows Borrower's equity grows declines At end of loan, the borrower Owes nothing to the lender Has substantial equity Owes nothing to the lender Has substantial equity Owes substantial amount to lender Has much less, little, or no equity Modes of repayment Monthly (during loan period) Monthly (during loan period) Sale proceeds of house property used to settle the loan dues, on borrower's demise or giving up home Bullet repayment of principal and accumulated interest Borrower/heirs have option to prepay or settle loan dues without sale of property No Negative Equity Guarantee Not available Not available RMLs typically carry 'no negative equity guarantee' i.e. if the sale of the residential property does not cover the outstanding loan,
the borrowers or the estate will not be asked to make up for the shortfall, if any, subject to fulfillment of the agreed terms and conditions. Why did this scheme not become that popular? Reports seem to indicate that a very small percentage of senior citizens only seem to have taken advantage of the facility since its inception. This could be perhaps because better awareness had not been created about the product. Secondly, the Indian banking industry caps the available loan amount at Rs 50 lakh (Rs 5 million), instead of providing for an equitable percentage of the property's value, and limits the loan period to a tenure of 15 years. Despite the potential for reverse mortgage, there are several issues that may slow its spread as a reliable and acceptable means of income generation. It is a complex instrument and exposes the typical uninformed elderly borrower to fears of a debt burden. The real estate market is not mature in India and much longer term trends in home appreciation are required to accurately value homes.