Reverse mortgage BY BABASAB PATIL

1. Reverse
Mortgage
By:- Babasab Patil

2. Introduction to Reverse
Mortgage
Until recently, there were two main ways to get cash from your home the
first one is you could sell your home, but then you would have to move and the
second one is you could borrow against your home, but then you would have
to make monthly loan repayments. Now there is a third way of getting money
from your home that does not require you to leave it or to make regular loan
repayments that is “Reverse Mortgage”. A reverse mortgage is a loan against
your home that you do not have to pay back for as long as you live there. With
a reverse mortgage, you can turn the value of your home into cash without
having to move or to repay a loan each month. No matter how this loan is paid
out to you, you typically don‟t have to pay anything back until you die, sell
your home, or permanently move out of your home. Reverse mortgages is a
powerful tool to help eligible homeowners obtain tax-free cash flow
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3. History and Origin of reverse
mortgage
The history of reverse mortgage goes back to 1961.In the year 1961 the first
reverse mortgage loan was made by Nelson Haynes of Deering Savings & Loan
(Portland, ME) to Nellie Young, the widow of his high school football coach.In
the year 1963 the first property tax deferral program offered in Oregon,
financed through Public Employees Retirement Fund.In 1970 Survey research
on a "housing annuity plan" was conducted in Los Angeles by Yung-Ping
Chen of UCLA. In 1975 Technical monograph on "Creating New Financial
Instruments for the Aged" authored by Jack M. Guttentag of The Wharton
School.In 1977 First RM loan program, "Equi-Pay", introduced by Arlo Smith
of Broadview Savings & Loan in Independence, OH.In 1978 "Reverse
Mortgage Study Project" funded by Wisconsin Bureau on Aging, directed by
Ken Scholen and First statewide deferred payment loan program offered by
WI Dept of Local Affairs and Development, designed by William Perkins.In
1979 First national "Reverse Mortgage Development Conference"sponsored
by WI Bureau on Aging in Madison
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4. The Benefits of a Reverse
Mortgage
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Tax-free funds for as long as you live in your home
No loan repayment for as long as you live in your home
No income, medical or credit requirements
Retain ownership of your home for life this is guaranteed
as long as you maintain your home, and pay insurance and
real estate taxes
 Choose a cash flow plan tailored to your needs
 No restrictions on how you may use the funds
 A tax-advantaged way to pass on part of your estate today
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5. Guidelines given by RBI for
Reverse Mortgage: Any house owner over 60 years of age is eligible
for a reverse mortgage.
 The maximum loan is up to 60% of the value of
residential property.
 The maximum period of property mortgage is 15
years with a bank .
 The borrower can opt for a monthly, quarterly,
annual or lump sum payments at any point, as per
his discretion.
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6. Costs which are to be incurred while
going for Reverse Mortgage
A. Processing or origination costs: - These are the costs
which covers the bank‟s operating expenses for making
the loan .This cost can be financed as a part of the total
loan.
B. Mortgage Insurance: - This is the insurance charges of
the insurer who guarantees that if the lender that is the
banker goes out of business for any reason, the borrower
would continue to get his or her payments. The insurer
could also guarantee that the borrower will never owe
more than the value of his or her home when the loan is
finally repaid.
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7. Conti……..
A. Appraisal fee: - This fee is to be paid to an
appraiser who fixes a value on the borrower‟s
home which is to be mortgaged. An appraiser
must also make sure there are no major structural
defects, such as bad foundation, leaky roof, or
termite damage. If the appraiser uncovers
property defects, you must hire a contractor to
complete the repairs. Once the repairs are
completed, the same appraiser is paid for a
second visit to make sure the repairs have been
completed. The cost of the repair may be
financed within the loan.
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8. Conti………..
 The revaluation of the property has to be
undertaken by the Bank once every 5 years.
 The amount received through reverse mortgage is
considered as loan and not income; hence the
same will not attract any tax liability.
 Reverse mortgage rates can be fixed or floating
and hence will vary according to market
conditions depending on the interest rate regime
chosen by the borrower.
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9. Risks to Reverse Mortgage
Lenders
There are some risks faced by a Reverse Mortgage
lender. These risks are at the heart of the reluctance of lenders
to get into reverse mortgage lending, in the absence of public
policy support. The principal and unique problem facing the
lender is that of predicting accumulated future loan balances
under a reverse mortgage, at the time of origination. The
uniqueness is because reverse mortgage is a „rising debt‟
instrument. Since reverse mortgage is a non-recourse loan,
the lender has no access to other properties, if any, of the
borrower. Even if the collateral property appreciates in value,
it might still be lower than the loan balance at the time of
disposal of the property. The following are the basic sources
of this risk:#

10. Mortality Risks
This is the risk that a reverse mortgage borrower lives longer than
anticipated. The lender might get hit both ways he has to make annuity
payments for a longer period; and the eventual value realised might
decline. However, this risk is usually „diversifiable‟, if the reverse
mortgage lender has a large pool of such borrowers. Possibility of adverse
selection is counterbalanced by the possibility that even borrowers with
poor health may be attracted by Reverse Mortgage‟s credit line or lump
sum options. However, there is no literature on one possible source of
systematic risk. Since reverse mortgage is projected to substantially
improve the monthly income and/ or liquid funds of the reverse mortgage
borrowers, would it not itself result in a systematically higher life
expectancy amongst them than otherwise, now this is a big question.
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11. Interest Rate Risks
Said that the typical reverse mortgage borrower is elderly
and is looking for predictable sources of income/ liquidity,
reverse mortgage loans promise a fixed monthly payment /
lump sum / credit line entitlement. However, for the lender,
this is a long-term commitment with significant interest rate
risks. While fixing the above, the lender has to account for a
risk premium and thus can offer only a conservative deal to
the borrower. This interest rate risk is not fully diversifiable
within the reverse mortgage portfolio. Most of the reverse
mortgage loans accumulate interest on a floating rate basis to
minimize interest rate risks to the lender, like in SBI the
interest rates are revised for every 5 years. However, since
there are no actual periodic interest payments from the
borrower, these can be realized only at the time of disposal of
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the house, if at all.

12. Moral Hazard Risk
Once an RM loan is taken, the homeowners may have no
incentive to maintain the house so as to preserve or enhance
market value. This might be especially true when the loan
balance is more or less sure to cross the sale value. Since the
benefit would accrue mainly to the lenders and the cost borne
by the homeowner, it is perhaps not sensible to assume
otherwise. They conclude that in a competitive market, the
lenders will respond by either reducing the loan amount or by
charging a risk premium in interest or both. The more
important point is that some time during the tenure of a
reverse mortgage, an elderly borrower may simply be
physically incapable of maintaining the home as per loan
requirements.
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13. Risk Mitigation
• Risk mitigation is the key for the success of any financial
product including reverse mortgage. Some of the risk
mitigation techniques which the providers that is the banker
can apply to reduce the risk on their books are as follow
1. Proper eligibility criterions:• The first mitigation of risk can be done at the time of
providing loans. This can be done through proper verification
of the title of the property, age of the borrower; his/her credit
analysis etc. This reduces the risk of default by the borrower
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14. Conti………
1. Variable interest rates loan as compared to fixed
interest rate loan:-To avoid interest rate risk, the lender
can go for variable interest rates based on some market
benchmark like MIBOR. This will also reduce the risk of
Pre-payment as the borrower will not have interest
arbitrage on prepayment of the loan
2. Proper analysis of mortality trends:-As the product has
significant longevity risk, the lender can do a detailed
mortality trend analysis on a macro level and also in the
market where it is operating.
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15. Conti………
1. Geographical diversification :-The lender can look at
spreading the business across the country by promoting
the product in secondary and tertiary cities also so that the
law of large numbers may work properly and if the
provider has a bad experience in one market; it can be
compensated with good experience in other cities
2. Develop the product for lower age groups:-The lender
can develop home equity conversion mortgages for all
households and not just for elderly. This will significantly
reduce loan to value ratio and that will take care of many
of the risks inherent in the product.
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16. Conti………
1. Securitization :-One of the most effective ways of mitigation
risk is securitization It involves many other financial players and
thus it spreads the risk of default/prepayment to many other
participants.
2. Repayment schedule :-In the Repayment schedule, some
default conditions or changes that affect the security of the loan
for the lender that can make reverse mortgages payable should
also be added, like Declaration of bankruptcy, Donation or
abandonment of the house, Condemnation/ Sovereign Takeover
of the property by a government agency, adding a new owner to
the home‟s title, taking out new debt against the home etc.
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17. Forces affecting “Reverse
Mortgage”
Any financial product is affected by some forces. The
following are forces that affect this innovative financial
product called “Reverse Mortgage”.
 Borrowers have to bear very high transaction costs.
However, with the latest program we can expect a
declining trend in these costs due to growing volumes,
increased awareness and learning effects.
 There is a definite risk of moral hazard in borrowers being
responsible for home maintenance and in ultimate home
sale. Given the profile of a typical borrower, there are
serious questions on both incentives and ability. It is
impractical to enforce the foreclosure clause
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18. Conti…….
 Home equity is an important component of precautionary
savings. If a homeowner has drawn down on his equity
through a reverse mortgage, his ability to meet unforeseen
health care costs or move into alternative housing may be
more limited. Those who become seriously ill but would
like to continue to stay at home may face a severe problem.
If they have to be away from home for long for
convalescence, they may fail to maintain the home and pay
property taxes. Then, as per the conditions of the reverse
mortgage, the lender can foreclose the loan.
 Many elderly households may be simply reluctant to take
on debt, having spent so much of their lifetime saving for
their own house.
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19. Conti…….
 Real estate laws are state specific whereas regulations
governing reverse mortgage loans are national in character.
If there is a conflict, state laws will prevail unless preempted by federal law.
 Laws in some states are not clear on the lien priority to be
granted to reverse mortgage over other secured creditors,
in spite of specific provisions in a reverse mortgage
contract.
 What happens if a household declares bankruptcy, having
borrowed through a Reverse mortgage is a big question.
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20. Conti…….
 Uncertainty exists on taxation of the borrower. If reverse
mortgage annuities were considered taxable as income of
the borrower, would accrued interest on the loan be a taxdeductible expense is an issue.
 The tax authorities may if classify an reverse mortgage as a
sale of home rather than a loan, given the high probability
that the entire value may ultimately accrue to the lender. If
so, the borrower may suddenly find that he has lost out on
one-time exemptions on capital gains.
 The lender has to account for accrued interest as income,
without any corresponding cash flow.
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21. Thank You
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