"A reverse mortgage is a loan available to seniors and is used to release the home equity in the property as one lump sum or as multiple payments. The homeowner's obligation to repay the loan is deferred until the owner dies, the home is sold, or the owner leaves (e.g., into aged care)"
The analysis of definition provides us some basic features of reverse mortgage products.
These are :
- The loan is available only to senior citizens owning a home
- The loan can be in the form of lump-sum or multiple payments like annuity etc
- Homeowner does not have obligation to repay the loan till the house is his prime residence.
A reverse mortgage is analogous to an annuity where the principal and interest are paid with homeowner's equity. In a conventional mortgage the homeowner makes a monthly amortized payment to the lender; after each payment the equity increases within his or her property, and typically after the end of the term (e.g., 30 years) the mortgage has been paid in full and the property is released from the lender. In a reverse mortgage, the home owner makes no payments and all interest is added to the lien on the property. If the owner receives monthly payments, or a bulk payment of the available equity percentage for their age, then the debt on the property increases each month.
If a property has increased in value after a reverse mortgage is taken out, it is possible to acquire a second (or third) reverse mortgage over the increased equity in the home. But in certain countries (including the United States), a reverse mortgage must be the only mortgage on the property. The payback is done once the owner dies or leaves the house. This is done though selling the house and recovering the loan through its proceeds.
Thus a home owner going for reverse mortgage may take his payment in the following form.
- A lump sum at the beginning (can be used for home improvement health expenses etc)
- Monthly payments till a fixed term
- Monthly payments as a life-long annuity
- Establishing a credit-line with or without accrual of interest on credit balance
- A combination of the above
Some lenders have come out with plans different from the above to suit the requirements of the borrowers. Some of such plans are
1. Home Reversion / Sale and Lease Back
The homeowner sells the house but keeps the right to live in the house till the time it is his prime residence. The amount could be used for home improvement, any other health need etc.
2. Interest-only Mortgage
The borrower takes lump sum and pays only interest during his lifetime. The principal is recovered through the sale of the home.
3. Mortgage Annuity/ Home Income
The loan is used to purchase an annuity for the homeowner. The advantage is that even if the homeowner moves out of the home, the annuity will continue till his death
4. Shared Appreciation Mortgage
This provides loans at a below market interest rate .In return, the lender gets a pre-agreed share in any appreciation in the property value over the accumulated value of the loan.
A reverse mortgage loan is a loan where the lender pays the monthly installments to you instead of you making any payments to the lender. Hence the name reverse mortgage, as the payment stream is reversed. A Reverse mortgage enables senior citizens to convert their home equity into tax-free income. Reverse mortgages enable eligible homeowners to access the money they have built up as equity in their homes. They are primarily designed to strengthen seniors’ personal and financial independence by providing funds without a monthly payment burden during their lifetime in their home. The major eligibility requirements are that the applicant must be at least 62 years of age and own and occupy a home as their personal residence. The type of home that qualifies as a personal residence can be a single family residence, town home, condo, multiple unit building (1-4 Units), or mobile homes with a permanent foundation built after July 15, 1976. Co-ops do not qualify.
The best way to explain what a reverse mortgage is and can do is to give some examples :
A 76-year-old widow has a home worth $1,000,000 with an existing mortgage balance of $218,000. She wanted to make some improvements to her home, but did not have the cash flow from her Social Security and pension; a larger conventional mortgage would not help. A reverse mortgage paid off the $218,000 mortgage and gave her $39,000 at close of escrow for repairs. A credit line was then established in the amount of $81,000 that will grow at a 5% per year rate.
A husband & wife, ages 70 & 66, were recently married and wanted to travel. Their home was valued at $650,000 with an existing loan balance of $20,000. Their combined income was $3,200 per month.
A reverse mortgage paid off the $20,000 conventional loan and established a $178,000 credit line that grows at 6.97% per year. They can pull from the credit line anytime they like and have the funds wired to their account within five business days.
Oakland, California A 76-year-old single widow had an existing loan balance of $145,000. Her home was valued at $600,000 and she was getting behind on her bills. A Reverse mortgage paid off the existing mortgage and will provide a monthly payment of $336 per month for as long as she lives.
Union City, California
A husband and wife, ages 69 & 66, had an existing mortgage of $190,000. They could make the payments but could not do much else. A Reverse mortgage paid off the $190,000 conventional mortgage and eliminated the $1,100 monthly payment they used to make on the mortgage.
San Francisco, California
A single woman had a reverse mortgage from years ago and wanted to fix up here lovely home in the hills. She refinanced and created a credit line of $150,000 that grows at 7.74% on the balance she leaves in the credit line. It is very common once a reverse mortgage is completed to refinance in later years or every year to access more equity. This can be done because HUD raises the Lending Limit each year. In January 2005 HUD raised the limit $22,000. In January 2006 HUD raised the limit $50,000. Every year HUD raises the limit on January 1st.
The various considerations which needs to be taken while pricing a product of this nature are :
- Age of the borrower : If it is a joint borrowing then the age of the younger borrower is considered
- Value of the property : Then value of the property plays a major role in determining the price for an RM (Reverse Mortgage) product.
- Expected Interest Rate : As the product resembles the normal annuity product in some sense, the current and expected interest also plays a major role in pricing the product
As can be seen from the above, we can find that the product has taken many forms during its evaluation. But is there a real need of reverse mortgage in India?