The finance minister while presenting the union budget, 07-08 announced that national housing bank will introduce a scheme namely “reverse mortgage” for the senior citizens. It was to palliate their sustenance. In pursuance of this announcement some of the banks have already formulated such schemes. The plot behind this is to secure a stream of cash flows against the mortgage of a residential house without alienating the property. Senior citizens who hold house property but have dearth of funds can mortgage their property with a bank thus, monetizing the house as an asset. Lender makes periodic/lump sum payments to the borrower during the latter’s lifetime. Receiver can choose the way the payments will be made.
Senior citizens are not required to service their loan during their lifetime. On the Borrower’s death or if he leaves the house property permanently the loan is repaid along with accumulated interest through the sale of house property. Borrower/Heir can also repay or prepay the loan with accumulated interest and have the mortgage released without resorting to the sale of the property. Loan amount granted under reverse mortgage scheme is maximum up to 90 percent of the value of the property but varies from bank to bank, range being 50 -90%. Minimum amount that can be granted is three lakhs and maximum up to 1 crore in general, but this may also vary for different banks. Example of such a scheme is PNB BAGHBAN. This scheme is for those above the age of 62 years. It facilitates the senior citizens. Banks depute their officials dedicated for this work, who visit the senior citizens and do the necessary documentation. Reverse mortgage professionals ascertain the value payable by banks in the form of installments to mortgagee. The cash flows are affected by the market value of the property.
HOW IS IT DIFFERENT FROM A SIMPLE MORTGAGE
In a regular mortgage, the borrower mortgages his existing property and utilizes the amount granted by the bank for any other purpose and is required to repay the loan in the form of equated monthly installments (EMI) which would include loan and accumulated interest. The property mortgaged serves as a collateral security for the loan borrowed. However in case of reverse mortgage, the person pays EMI to the bank for the mortgaged property.
WHY IS SCHEME NOT A SUCCESS?
This scheme is an otiose in India due to some glitches. One of the reasons for its conk out In India is a custom of passing on the property to their successors/heirs. Some other reasons for its break down are that on the succession, if the inheritor fails to pay the amount due, the house is required to be sold out. Also, other better options exist which make this scheme redundant.
Alternate option to this scheme is a person may opt to sell the existing property and then use some of the proceeds to buy another property at a price lower than that of original house property and could use the balance amount for investment, so that annuity can be generated which would serve as a source of income.
HOW IS THIS SCHEME A BOON?
Benefit of reverse mortgage scheme is that even if the property is mortgaged the person still can reside in that property.
The following transaction of transferring a capital asset will not be regarded as a transfer and number capital gains will arise
Section 10(43) – Any amount received as a loan , either in lump sum or in installment in a transaction of reverse mortgage is exempt from tax i.e. not be treated as income of the senior citizen although loan is a capital receipt but to promote the scheme income has been exempted.
FACTORS TO BE CONSIDERED
For ascertaining the amount payable by banks under reverse mortgage are age, current interest rate, house property’s value, maximum loan limits determined by regulatory authorities, any outstanding mortgage or any other lien on the property (if any) should be considered.
House must be freehold else all existing liens will be set off against the proceeds. If there is an existing mortgage balance it can be paid off with the proceeds of reverse mortgage loan at the closing. Generally, no credit score requirements exist for this scheme.
Loan will not become due as long as one of the owner lives in the house as a primary residence. Owner is required to pay the insurance and property taxes even if opted for the scheme. In case of death or in case house property ceases to be the primary residence, successors can either choose to repay the loan or put it for sale.
SET BACKS OF REVERSE MORTGAGE
Since reverse mortgage is a loan it requires some origination and other fees to be paid which are exorbitant and the interest rate which is charged on loan is also very high as compared to interest rates which are charged on other loans.
Heirs if do not repay the loan will lose the property which they would have otherwise inherited, in case the owner no longer resides in the house property i.e. moves out for a year the loan becomes due .The taxes and insurances and other related charges will continue to be borne by the owner.
TYPES OF REVERSE MORTGAGE –
Single purpose reverse mortgage – they are the least expensive option and can be used for only one purpose as specified , the ones having low and moderate income can opt for this scheme;
Federally insured reverse mortgages – are generally more expensive than other home loans , they can be used for any purpose , opted when one plans to live in a house for a short period of time or need to borrow a small amount , they are easily available , have no medical or income requirements and can be used for any purpose;
Propriety reverse mortgages-are private Loans
THINGS TO BE TAKEN CARE OFF
Before opting for the scheme one needs to be vigilant about the insurance fee, other closing costs ; some schemes charge fixed interest rates, some charge variable interest rates which are related to market conditions,
Interest on reverse mortgages is not allowable as an expense unless loan is actually paid off i.e. it is allowed on actual payment basis.
OPTION TO CANCEL
The borrower has a prerogative of cancelling the scheme within the prescribed time limit. No penalty will be charged if cancellation is made within the prescribed time for any reason. It may be done by notifying the lender in writing.post the letter through a certified mail and ask for a return receipt as an acknowledgement. Keep the copies as a proof of cancellation. After cancellation lender has 20 days to return the money.
Example:-suppose MR x purchased a house property in 1974 for Rs 2 Lakhs and its fair market value as on 1.4.1981 is Rs 5 lakhs.MR X had mortgaged the property to a bank in reverse mortgage scheme and has received loan of Rs 40 Lakhs on the property. Interest thereon amounted to Rs 10 lakhs and the total loan and interest outstanding is Rs 50 Lakhs.
Case 1- MR X discharges the loan of Rs 50 Lakhs to the bank and sells the property for Rs 90 Lakhs on 1st January 2013.
Capital gains in the hands of Mr. X in assessment year 2013-2014 shall be
Sale price 90 Lakhs
Minus cost of acquisition 5 Lakhs* 852/100
Case 2- MR X dies and his son y discharges the loan of Rs 50 Lakhs to the bank and sells the property on 1st jan 2013 for RS 90 Lakhs. Here the case of R.M ARUNACHALAM shall apply and the capital gains in the hands of y in assessment year 2013-2014 shall be
Sale price 90 Lakhs
Cost of acquisition (-) 5 lakhs *852/100
Cost of improvement (-) 50 lakhs
Case 3-IF MR X dies and his son Y does not repay the loan to the bank, bank sells the property on 1st jan 2013 for Rs 90 lakhs. Bank recovers the amount of Rs 50 lakhs and pays the balance 40 lakhs to MR X.
Amount taxable in the hands of MR X
Selling price 90 lakhs
-Cost of acquisition 5 lakhs *852/100
Case of RM ARUNACHALAM shall not apply since the son has not discharged the loan
Glimpse of Case of RM ARUNACHALAM (Supreme Court) referred above-in the above case
Facts of the above case are as under-
MR. David purchased a house property on 1st jan 1985 for Rs 10 lakhs. He took a loan of Rs 8 lakhs by mortgaging the said property to Mr Alfred. Mr david died on 21st jan 1994 and his son Mickle inherited the property from him. Mickle discharged the loan of Rs 8 lakhs to Alfred on 1st jan 1997 and cleared the mortgage of the property. Mickle sold the property on 1st jan 2013 for Rs 30 lakhs. For the purpose of computation of capital gains he took the cost of acquisition as 18 lakhs but the assessing officer is of the view that cost is the cost of acquisition to the previous owner that is 10 lakhs. The Supreme Court held that the assessee was justified in taking the cost to be Rs 18 lakhs. Under sec 49(1) where the assessee acquires the 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 the 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 mortgager in the favour of mortgagee. When the previous owner had mortgaged his property then after his death the legal heir inherits only the mortgager’s interest in the property. By discharging the mortgage debt his heir who had inherited the property acquires the interest of the mortgagee in the property. As a result of such payment made for clearing off the mortgage, the interest of the mortgagee is acquired y the heir. The said payment is therefore 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 the amount paid to clear the mortgage. This judgment relates to an assessment year when the concept of indexation was not there but now the amount paid to clear the mortgage debt should be regarded as cost of improvement.
This scheme has certain pros and corns. Though introduced for the benefit of senior citizens, the scheme turned out to be a flop show due to some impediments as mentioned above.
For those who choose to opt the scheme certain points should be considered, reference of which has already been given. But this scheme can serve the needy senior citizens to create a regular source of income. The worst problem with reverse mortgage is that of misuse of funds. The negative side says that the receipts are lesser in comparison to the interest that is charged. Interest charged is sky high thus amount to be repaid is also sumptuous as compared to the principal loan granted. There is a general belief that those reverse mortgage scheme holders end up in a financial crisis this is not true. Major chunk of those who exercise the scheme choose to soar their pension and the minority chooses to take the amounts in lump sum. Since senior citizens want funds gradually so Reverse Mortgage is a laudable scheme. Reverse mortgage is more of debt by its nature and the most expensive form of credit due to the high interest rate being charged. The scheme is only worthy until the house is occupied, on leaving it for more than 12months loan becomes payable. It might ultimately make the elderly homeless. And also if the senior citizens fail to pay property taxes, insurance premium or other related taxes or fail to maintain the house they are deemed to be in default the lender can then foreclose. They can either purchase at nominal rates and can thus dispose at high prices the difference being the profit which is generally very high. Therefore, Reverse Mortgage is a good option only for those senior citizens who choose to reside in the same.