We are all aware of the mortgage or the housing loan that we avail of when we buy a house.

The value of a house is usually much higher than what we can afford today. By putting in some amount ourselves say around 15-20% and taking the balance from a bank as a home loan, we are able to buy our dream-house today.

This loan is then repaid to the bank together with the interest over say next 15-20 years, in the form of EMIs (equated monthly installment) i.e. a fixed amount every month.

Reverse mortgage, as the name suggests, is just the opposite. To put in very simple terms, herein you already own a house, which you mortgage to a bank. Against this, the bank pays you a fixed amount every month. In other words, the bank pays you an EMI, while you continue to stay in your house.

Therefore, unlike a home loan where you debt decrease with time, in reverse mortgage it increases as years go by - as both principal and interest increase with each payment your receive. 

The important point to note here is that this loan is not repayable – at least not in cash. At the end of the mortgage period, the house becomes the property of the bank, which then sells it off and recovers its’ loan amount plus the interest from the sale proceeds.

There could, of course, be many variations to the above transaction. For example, instead of taking a fixed monthly amount you can get some amount as lump sum in the beginning. Or maybe a credit line could be set-up, against which you can draw money as and when needed. But the essential nature remains the same – you are selling your house in installments, while continuing to stay there.

Think from the perspective of old retired persons, who usually have a place to stay but not enough money to meet their day-to-day expenses. For them this option works beautifully. They get a monthly cash flow and live in comfort for say next 15-20 years, by which time they would have left for the heavenly abode. The bank then takes over the property for sale and recovery of their loan.

Therefore, by reverse mortgage we are converting a dead asset into a useful income.

National Housing Bank (NHB) has recently taken steps to introduce this product in India, though it is quite common in the US. This scheme would provide greater financial security for the elderly, especially those who either prefer or are forced to live independently in their twilight years. Now, they need not rely on their children or family or the government to support them.

This may prove to be a useful scheme in India, where more than 90% of the population does not enjoy any old-age benefits like pension or social security.

However, there are certain issues – operational, legal and emotional - which need to be sorted out, before the scheme can become popular.

Operational issues

NHB has to fix certain eligibility norms. One very obvious norm would be that you should the owner of the property (which is ideally debt-free) and you are residing in it.

Apart from this there could be age criteria. For example, in US the person must be at least 62 yrs of age to be eligible to borrow under reverse mortgage. Further, older homeowners get larger amount of loan vis-à-vis the younger borrowers.

Interest rate would be another criterion. The loan tenure is another tricky issue. NHB has proposed a maximum of 15 years; which is a debatable issue. What happens if the owners survive this period? Does the borrower get evicted?

Then, there would be the issue of valuation and the maximum percentage of age that the bank would be willing to finance.

Financing fees, insurance, maintenance, property taxes etc. would be the other minor issues that would need ironing out.

Legal issues

The necessary regulations have to be put in place. This would require new laws apart from amending some of the existing ones such as the NHB Act, RBI Act, etc.

Besides, there is a tax angle to all this. Should this amount received from the bank be treated as income (and hence taxable) or a loan (therefore, no tax)?

Further, as the experience in US shows, mortgage insurance would become important. This would protect the bank in case there is a shortfall in the sale proceeds vis-à-vis the loan amount. Otherwise, it is the lender, which bears the loss. The borrower is not asked to pay the difference, if any. Nor can he be forcibly evicted.

Emotional issues

A house is considered to be a very dear asset in India. It has a very high emotional value attached to it. Therefore, creating a debt on it will require a big change in the present mindset.

Also, house is something, which one usually leaves behind as a legacy for ones’ children. Therefore, to give it away to a bank would be another mindset hurdle to overcome. (Old age homes are passe. Say hello to 'retirement' homes)

Reverse mortgage is a new product and there are bound to be some teething problems. Not withstanding all the above issues, which seem quite challenging, the reverse mortgage is a product, which offers an option to the old people to continue to live with dignity.

Note:-Dewan Housing Finance Corporation has very recently launched one such scheme. A home owner of 60 yrs or more will be eligible to receive EMI for 15 years @12% i.e. for every Rs.1 lakh of property value, bank pays an EMI of Rs.205/month. Further, on survival after 15 years, the owner continues to stay, while the loan accrues interest @12% p.a.

The author, Sanjay Matai, is an investment advisor and can be reached at sanjay.matai@moneycontrol.com.

Read more articles by the author: