Can reverse mortgage be used as an income source after retirement?

Published: February 10, 2022 at 6:00 am

In this article, we discuss the pros and cons of using a reverse mortgage as an income source after retirement.

How does a reverse mortgage work? Suppose you live on your own property with your spouse. You mortgage the house to a bank in exchange for a lump sum or periodic payment. That is, you hand over your property papers to the bank in exchange for this amount.

You and your spouse can continue to live in the property for the rest of your lives and receive monthly payments (if you choose the monthly portion) for a maximum tenure of 20 years. Interest on the loan will continue to accrue until the property is disposed of or repurchased by legal heirs.

You and your spouse are under no obligation to settle the loan in your lifetime.  After both of you have passed on, or permanently shifted to another residence, the bank will sell the property and square off the loan including interest.

Any surplus due to an increase in property value shall go to the legal heirs. The legal heirs can also buy back the house from the bank. In case the property value has dropped or the principal + interest amount is higher and the bank cannot square off the loan amount in the sale, it will be deemed as a loss for the bank. The legal heirs need not settle the loss.

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    To reiterate, even though the maximum payment tenure is 20 years, the couple can live in the property for the rest of their lives.

    Now all this sounds nice and rosy at first sight. There are several restrictions in place.

    • You can only reverse mortgage self-occupied property. That is, the property should be your primary permanent residence.
    • Typically only self-acquired property is eligible. Ancestral property may not be eligible.
    • Home insurance is a mandatory requirement after the reverse mortgage is approved.
    • If unmarried the person should be a senior citizen (60+). If a couple, one spouse should be 60+ and the other 55+.
    • The residual life of the property should be at least 20 years. This is the most important restriction in deciding not only eligibility but also the amount the bank will be will lend.
    • The property value will be evaluated by the bank. The bank will not use the value you hear on the street or from your broker. This means the payout is likely to be lower than you would imagine.
    • In any case, the maximum monthly payout (which is tax-free) is capped at Rs. 50,000 and quantum of loan cannot exceed Rs. 1 crore.
    • Up to a maximum of Rs. 15 lakhs can be borrowed to handle medical emergencies.
    • The rate of interest is currently a health double-digit number but will be subject to revision every five years. For example, Union Bank offers 12.15%.
    • Only three days are given to senior citizens to cancel the agreement if they choose to change their minds!
    • The borrower (that is the senior citizen and spouse) cannot leave the property vacant for more than a year! They will have to pay property/sewage taxes regularly. They cannot change the ownership of the property. They will have to maintain the property and pay insurance on it!
    • The borrower is expected to use the payout for essential day to day expenses and not speculate with it!

    Who can consider a reverse mortgage?

    • Senior citizens who are are asset rich, cash poor. That is they do not have much liquid net worth to speak of and have trouble meeting ends after retirement.
    • Senior citizens who have no children or heirs to use the property after their time.
    • Those who love their neighbourhood (the logistics, the facilities, the support) and are unlikely/unwilling to move.

    Can we use a reverse mortgage to leave some money to our heirs?

    That is, opt for a reverse mortgage (even if we don’t need it). When the bank sells the property, the heirs will get some payout assuming the property has appreciated in value over the tenure of the loan.

    There is no way of knowing how big or small this payout will be or whether there will be one! The conditions of the agreement are quite restrictive. If the heirs sell it later, they will get that payout anyway (assuming we did not need the reverse mortgage in the first place).  We do not recommend this!

    Who need not consider a reverse mortgage?

    • Senior citizens who are likely to relocate close to their children or to a retirement home
    • Those who are not emotionally attached to their homes and do not mind selling them to fund their retirement. This may be potentially more rewarding and in any case free from any restrictions. A one to one comparison between a reverse mortgage vs selling the property is not easy to do!

    It must be understood that a reverse mortgage is not a permanent source of income like a pension or insurance annuity. The bank may not be willing to offer the loan to the maximum tenure of 20 years!

    We will know the actual quantum of payout only after the bank has evaluated the property. This means if we choose to say no, we will have to forgo a good chunk of the processing fee (which will vary from bank to bank). For example, SBI charges 0.5% of the loan amount, subject to a maximum fee of Rs. 20,000 + tax.

    In summary, we recommend using the reverse mortgage option only as a last resort option as it is too restrictive.

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