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Reverse mortgage as its name indicates operates in a manner opposite to that of the typical mortgage such as a home loan. In a typical mortgage, you borrow money in lump-sum right at the beginning and then pay it back over a period of time. In your payback -- the EMI -- a portion goes towards paying the interest and the remaining goes towards paying back principal.
All along, you pledge the asset -- namely the home you have bought with the loan -- to the bank. This asset is the security against which the bank is lending to you. In reverse mortgage, you pledge a property you already own (with no existing loan outstanding against it). The bank in turn gives you a series of cash-flows for a fixed tenure. These can be thought of as reverse EMIs.
There are various forms of reverse mortgage available in the developed countries. The specific format National Housing Board (the facilitator for housing finance in India) is promoting is one in which the tenure is 15 years and the owner of the house and his/her spouse continue to live in the house till their death -- which can occur later than the tenure of the reverse mortgage.
Simply put, in case of Mr. and Mrs. Patil, if they were to opt for reverse mortgage for tenure of 15 years, they will get annuity (the reverse EMI) from bank for 15 years. After that, the annuity payments stop.However, they continue to live in the house. Assume that Mr. Patil dies after 17 years. Mrs. Patil can still live in the house till she is alive. After her death, the bank will give their heirs two options -- settle the overall outstanding loan and retain the house or the bank will sell the house, use the proceeds to settle the outstanding loan and give the rest to the heirs.
The bank bears the risk that the outstanding will exceed the market value of property then and will not ask for the difference from the heirs.The key question is -- how much of an annuity income can my house generates using reverse mortgage? The banks have so far not indicated which interest rates they will use to determine the EMI -- however, we can safely assume that it will not exceed the interest rates used for loan against property -- which is currently in the region of 12-14%.
Second significant variable is the loan to value ratio. Most loans against property work at 60% loan to value ratio -- i.e. by pledging a Rs 1 crore (Rs 10 million) property, you can get a Rs 60 lakh (Rs 6 million) loan. Some banks are however designing reverse mortgage products with a higher loan to value ratio -- as much as 90% in some cases.
The specific annuity paid out also depends on the age of the home owner. Higher the age, higher the annuity everything else being constant. For simplicity consider a 60-year-old home owner taking reverse mortgage with loan to value ratio of 80% and an interest rate of 12%.The annuity from reverse mortgage works out to be roughly ~Rs 160 per lakh of property value. Hence for Mr. Patil, with a property valued at Rs 80 lakh, the annuity he can expect will be in the range of Rs 12,800 per month.
Coupled with his income from financial assets, he can continue to live comfortably with no cutback on lifestyle. Suppose the value of your house is assessed at Rs 40 lakh (Rs 4 million) and you are 65 years of age. Under the present recommendations, you will be eligible to get a loan for 15 years that is till you turn 80 years of age.
Supposing you are eligible to unlock 60 per cent of the value of the house, then you can receive Rs 24 lakh (Rs 2.4 million) through reverse mortgage. And supposing you are eligible to receive Rs 8,000 every month, you will receive Rs 96,000 every year for the next 15 years, assuming that changes in the value of the property do not affect the payments to you.
At the end of 15 years you would have received a total of Rs 14.40 lakh (Rs 1.44 million). The interest component (compounded annually) on this amount, will be Rs 21.38 lakh (Rs 2.1 million).So the total amount that you owe to the bank will be Rs 35.78 lakh (Rs 3.6 million). However, if you die at end of the loan tenure, then the bank will sell the property to realize what you owe them, that is Rs 35.78 lakh, the balance will be passed on to your heirs.
Supposing the value of your property has appreciated to Rs 65 lakh (Rs 6.5 million) during the tenure of the loan, your heirs will receive Rs 29.21 lakh (Rs 2.9 million). However, if your heirs want to keep the property, they can settle the amount that you owe to the bank and keep the property