Reverse Mortgage Loan - A Savior for the elderly?
The Story of the Mehtas
Mr. Mehta is a 64-year-old individual who is retired for 3 years who stays with his wife Mrs. Mehta in Ahmedabad. They stay alone at their house while their children, a son and a daughter stay in Mumbai and Bangalore respectively.
Mr. Mehta is a proactive and informed individual and thus had planned for his retirement well in advance. Both of them are satisfied with their regular income from their investments for post-retirement expenses and thus don't require additional help from their children.
Mr. Mehta while had planned for the household expenses in his retirement planning, quite missed on increasing medical expenses due to their increasing age. Soon later Mr. Mehta started feeling tight on budget every month and quite found it difficult to make both ends meet with just his regular income from his retirement fund. Their children tried convincing Mr. Mehta to help him fund their expenses but Mr. Mehta was reluctant to seek help from his children.
He was a man of self-esteem indeed. He only thought of seeking help from his children as his last option.
Mr. Mehta came across a product while looking for alternative income sources which were Reverse Mortgage Loan. It is an option for senior citizens to convert their house into a regular source of income stream.
In the last article, we had a look at this product where we saw how this product works and what actually this product is. To visit the last blog click here.
The Correlation of the Case of Mr. Mehta and Reverse Mortgage Loan
So how does this product be able to help Mr. Mehta?
Is this product beneficial to Mr. Mehta?
Is this product at all beneficial?
Let us jump right in and understand this product from a technical point of view. Before I start let me warn you,
This article is going to be more technical so I'd suggest you - take a sip of your coffee or tea, and then read this article with a focus to understand the product completely. Let's jump right in.
Some Assumptions for the case study.
Mr. Mehta's Age - 64
Mrs. Mehta's Age - 63
Income from Investments - ₹32000/month
House Value at Market Price - 60 Lakhs
Interest Rate for Loan - 11% per annum
So, Mr. Mehta came across a product while looking for alternative income sources which was Reverse Mortgage Loan.
It is a type of product-cum-loan that can provide you annuity in exchange for your house.
The annuity will be provided regularly to the borrowers (Mr. & Mrs. Mehta) for a fixed period of time (generally 15 years) or till both of them live, whichever is less.
This means they will receive the same regular amount of income for 15 years or till the demise of both. Mr. and Mrs. Mehta doesn't need to pay back a rupee to the bank later on but the bank (lender) will recover their money by selling their house after their death.
Even if they live after 15 years the lender cannot ask to vacate their house. They can only do that after both of them die. The annuity will stop after 15 years but they can live as many years as they can in their house.
And as in these loans, both husband and wife are co-borrowers, both have equal rights to the loan so the death of one doesn't affect the income stream of the other. And the death of one doesn't mean that lender can vacate the house.
Mr. Mehta found this product quite interesting and started researching about this product. He consulted with his advisor and understood the crux of the product. He understood how will the value be determined. How much money monthly he can get with this product and so on. His advisor found a simple way to explain to him.
A Simple Analogy
Let's imagine the bank as an Investor. The house value of Mr. Mehta is what the bank wants after a certain period of time - in this case, a value equivalent to house value.
So if an investor wants to accumulate a certain value after a certain period of time by regularly investing a certain amount how can he do that?
By ascertaining a certain amount to invest every month or every year right?
So if an Investor wants to accumulate ₹60 lakhs after 15 years and approximately he will get a return of 11% pa so how much does he need to pay every month?
₹13100 each month or ₹156900 every year.
(Calculated using Time Value of Money formulas and Compounding effect)
Similarly so if the bank wants to get the house value recovered in 15 years (or whatever the period of the loan), there is a certain amount of money that the bank needs to pay (here the bank will pay to Mr. & Mrs. Mehta) to them so that to accumulate an equivalent value of the house.
So let's get back to the case study.
So the lender bank will pay an amount to the borrowers - Mehta couple equivalent to the house value in regular installments as per the borrower's requirement. This amount will be determined by:
- Value of the house
- Interest rate of the loan
- Frequency of payment (monthly, quarterly, semi-annually, annually)
- Period of the loan
- Age of the borrowers (not a major determining factor)
The value of the house is the most important factor that will determine what amount will the borrower get. Such value of the house is determined by various factors and the lenders adapt a particular system to arrive at a value. There are some factors that play a role which are:
- Condition of the house
- Life Value of the house
- Market Value
- Municipal Value
- Land Value
- & other minor factors
The mode of payment to the borrowers is majorly a regular payment in different frequencies but can also be available as a lump sum payment - one-time payment or as a line of credit (it's like a credit limit that the borrower can spend anywhere).
As discussed earlier, the lenders cannot vacate the house or sell it before both the borrowers die but this also doesn't mean that all of the responsibility of the house will be with the bank.
The borrowers still have to maintain the house like it's their own. They cannot sublet it or move to another place or even sub-let it. There are regular inspections by the lender of the property. Also all the taxes, insurance premiums have to be borne by the borrower.
So it is at all a beneficial product?
My verdict - Only consider it as a last option
These loans are reverse and don't work the traditional way. Like in the normal loan structure you get the upfront money first and then regularly pay it to reduce or write off your loans.
But in this case, the lender will receive the total money later on (15 years or even more if they survive and even less if they die early) and they have to pay regularly upfront so the amount you receive against your house value is actually less then what you think it will be.
For instance -
If in a regular loan, you borrow ₹ 60 Lakhs at an 11% rate for 15 years, your monthly EMI would be ₹67500.
While in Reverse Mortgage Loans which is the product here, if your house value is ₹60 lakhs and the rate is 11% and you will get regular income for 15 years, your monthly income would be a mere ₹13100.
It's the game of time value of money.
"Money received today is more valuable than money received tomorrow or a year later"
So, first of all, if you have to receive money from someone ask them to pay it today!
Because the bank is going to get the sum of money 15 years later and thus the amount you get is much lower.
I tried to find a proper calculator for Reverse Mortgage loans on many bank's websites but they had their calculations wrong. Every single bank had the original loan's calculation fed on the algorithm and thus provided a massive dif