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Reverse mortgage won’t attract tax if you are above 60 years

Reverse mortgage is for old people with low cash flow. It is a product for people who are asset rich but cash poor

If you are a senior citizen, your options for a pension product just got wider. You can mortgage your house and get tax-free income for life. In October, the government allowed payouts from reverse mortgage loan-enabled annuity product (RMLeA) to be tax free in your hands.

Reverse mortgage gives you a regular income by mortgaging your house, but so far only payouts from the basic reverse mortgage product were tax free. Payouts or annuities from the superior RMLeA were taxable. This made the product not only unpopular with customers but also with banks and housing finance companies. “Reverse mortgage has not become popular yet. This is mainly because the annuity-linked product till now did not have tax incentives.

Mostly state-run banks offer reverse mortgage and only about two banks offer RMLeA,” says R.V. Verma, chairman and managing director, National Housing Bank (NHB), the apex body for reverse mortgage schemes. Union Bank of India and Central Bank of India are the only two banks that offer RMLeA currently.

But there is an emotional hindrance too. “This is a generation that probably never borrowed and so is emotional about mortgaging the main asset earned through decades of hard work. The fact that the payout from RMLeA was taxable and the regular mortgage product didn’t offer substantial payouts only adds to it,” says Manish A. Shah, co-founder and chief executive officer, Bigdecisions.in, a portal that aids financial decisions through financial tools.

Even the sellers—housing finance companies and banks—don’t show interest in the product. “Reverse mortgage is not a popular product both quantitatively and qualitatively. Whenever we interact with bank teams, this is a product that never comes up. This is not on the top of anyone’s mind,” says Adhil Shetty, chief executive officer and co-founder, BankBazaar.com. Perhaps this is what translates into a sketchy knowledge among sellers. We tried to get a sense of how the payouts are calculated and got different, and in fact contradictory, answers.

But with payouts from RMLeA becoming tax free, this senior citizen product has got the much needed shot in the arm. Sellers of this product will need to get serious about explaining the benefits and the guidelines will have to become watertight and comprehensive. As more banks are expected to line up for RMLeA and you get ready to mortgage your home, it’s important you understand the concept of reverse mortgage. Read on to understand why RMLeA is better and how the product suffers from issues of clarity.
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What is reverse mortgage?
Reverse mortgage is the exact opposite of a home loan. You take a home loan to buy a house and until you are able to repay the loan, the house is pledged to the bank or the lender. You repay in equated monthly instalments (EMIs) and own the house subsequently. In reverse mortgage, you mortgage your house to the bank or the lender in return of a periodic payment. Eventually, the lender owns the house which it sells to recover the loan money along with interest. This product is designed specifically for senior citizens who own a house but do not have a regular stream of income from anywhere or would like to add to their pension money.

To be eligible for reverse mortgage, you need to be at least 60 years of age; there is no limit on the maximum age though. You can only mortgage a fully owned residential property in which you currently live. That means if you have more than one property, you can mortgage only the one in which you live and the property can be anywhere in India but not outside.

The regular reverse mortgage product that’s operated completely by the bank and RMLeA are similar till this point, but differ considerably in terms of payouts. A regular reverse mortgage will pay you an income only up to 20 years whereas RMLeA is designed for lifetime income. Here is how the two work.

Regular reverse mortgage
Regular reverse mortgage is a rudimentary product that is handled completely by the lending bank or the housing finance company. The amount of loan will depend on the value of the property, age of the person and tenor of the loan amount. As per NHB guidelines, you are entitled to a loan of 75-90% of the value of the house; this is also called a loan-to-value (LTV) ratio. Obviously, the lender will value your property and will have its own LTV ratio. We hit a big roadblock in calculating the illustrative payouts because we got three different understanding of how the interest will be factored and payouts calculated. We have chosen to go with the example given to us by Union Bank of India. In this case the interest rate would get reflected in the payout. Illustratively, a loan amount of Rs.90 lakh—value of property being Rs.1 crore and LTV being 90%—at a 12.75% interest will mean a monthly income of around Rs.8,218 for 20 years. Obviously if the rate of interest is higher, the payout will be lower.

Once the tenor is over, the payouts will stop but the borrower and the spouse can continue to live in the house. Upon their death, the first offer of sale of the house will be made to the legal heirs.

In case they are unable to repay the loan, the house is sold off, the bank recovers its dues and pays the balance to the legal heirs. “Banks will continue to levy interest on the loan amount even after the payment tenor is over until the bank recovers the loan,” adds Verma. “The basic purpose of availing reverse mortgage is to ensure a comfortable living with the help of equity value available in the possessed property. But a regular product limits the payout to 20 years. RMLeA on the other hand eliminates the risk of income scarcity due to life longevity,” says Shetty.

RMLeA
RMLeA in that sense takes off from where the regular reverse mortgage leaves you. The lender is involved up to the point of calculating the LTV ratio and assessing the value of the property. But instead of calculating the payout it makes a lump sum payment, equal to the LTV ratio, to a life insurance company. The insurer in turn works out a monthly payment, based on actuarial calculation, that it will pay for lifetime.
This monthly payment is called annuity in insurance parlance and is typically higher than the payouts you get from a regular reverse mortgage scheme. “Loan products are standard rule-based products with conservative lending norms forming the basis of calculations whereas annuity products are offered by insurers that apply more sophisticated pricing models to arrive at payout figures,” says Shah.

Put simply, a bank will take interest in giving you loan whereas the insurer will add to the payouts by investing the lump sum and earning a return on it. “Currently we offer lifetime annuities at a guaranteed 6% interest rate but if the investments earn more, we pass that on too to the customer as yearly bonus,” says Girish Kulkarni, managing director and chief executive officer, Star Union Dai-ichi Life Insurance Co. Ltd. Star Union is the only insurer currently that works with Union Bank and Central bank in providing RMLeA products. “Typically the annuity payout will be up to three times the payout from a regular reverse mortgage product,” adds Verma.

There are typically two kinds of annuities that Star Union is currently offering: One, with return of purchase price annuity pays the lump sum back to the bank with which the bank settles the principal amount and recovers the interest by selling off the property; and two, without return of purchase doesn’t give back anything. Without return of purchase price will offer the highest payout. “In both the products, you have the option of increasing your payout by increasing the loan amount. If the lender finds that the value of the property has increased substantially and is sustainable, it can increase the loan amount,” says Verma. Illustratively, for a loan amount of Rs.55 lakh the return of purchase price annuity will be Rs.24,709.

You need to keep in mind that since banks pay upfront to the insurer and annuities carry on for lifetime, banks will have a more conservative LTV ratio in giving you a loan. The guidelines on RMLeA prescribed by NHB restrict LTV to 60% for a 60-year-old borrower. “A borrower will need to understand RMLeA fully. Because the bank pays in lump sum to the insurer, the interest is levied upfront on the entire amount. Under regular mortgage, interest would accrue only on the payouts. So if a borrower dies in say a year, under RMLeA the bank will recover the entire loan amount whereas under the regular product only payouts will be recovered. Payback to the bank is much higher in RMLeA which needs to be understood by customers,” says Shetty.

What should you do?
If you are looking for a regular stream of income and don’t have enough investments to buy pension products, reverse mortgage is your answer. Even as the concept is appealing, the product at this stage is very raw with loopholes in regulatory guidelines and sketchy understanding. It’s important that you sit with the lender and understand not just the payouts but also how the banks will recover the money and communicate the same to your legal heirs as it will take a toll on estate planning as well. “It’s important to set the expectations of the rest of the family, those who stand to inherit the property after the borrower’s death,” says Shah. Opt for RMLeA. Annuity payout will put more money in your wallet for lifetime.

Article Courtesy: Livemint.com

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