Challenges in Reverse Mortgage – A Review
Supriya Sehgal
Assistant
Professor and Registrar-Outreach
JK
Business School
Dr. Vaishali Dhingra
Professor
and Joint Registrar
Teerthankar
Mahaveer University
A Reverse Mortgage is a type
of loan which is suitable for senior citizens aged 60 years or more. . Through this
loan instrument, the old age home owners can release the equity trapped in
fixed asset and use it during their grey years. The process of Reverse Mortgage
does not require the homeowner to pay any kind of loan repayment for buying a
home and allows taking the benefit of the house during their lifetime. It
provides needed cash for the sustenance of life, whose network is tied up in
the value of their home.
Aims and Objectives: The
main objective of this study is to study the factors that determine the success
or failure of Reverse Mortgage both from borrowers (senior citizens) and
lenders (banks and financial institutions) perspective.
Methodology: The current
study is qualitative in nature so that the secondary data collection method is
to be used which mainly includes books, journals, past articles, and
researcher.
Findings and Discussion: The
current study mainly focuses on evaluating the severity of borrower’s maintenance
risk in Reverse Mortgage from the borrowers and lenders perspective. The study
also classifies and identifies variance that is translated as an internal and
external perspective effectively. It also describes the findings and conclusion
which is based on the literature and academic reviews so that effective
conclusion will be done by making the consideration of the Reverse Mortgage and
the various factors that affect the borrowers and lenders while taking the home
loan and maintaining their risk effectively.
Keyword: Borrower,
Severity, Risk, Reverse Mortgages, Lenders,
Interest rate risk ,bequest , senior citizens
Akin to various other
countries in the world, India is also experiencing population aging. Due to
improved standard of living, better medical facilities, increasing urbanisation,
the life expectancy of an average individual has increased. But it has brought with itself another set of
issues. The dissolution of joint family system, increased cost of living ,
increase of medical issues in old age and virtual non- existence of social
security system in the country has raised many concerns for senior citizens.
Reverse Mortgage as presented a golden wheel (Goyal, 2014) to aged people as an
instrument to augment or to provide for the retirement earnings. A Reverse Mortgage a loan instrument by which
eligible senior citizens can take a loan against property possessed by them
from an approved lending institution (Rajagopalan, 2006). It is also known as a
mortgage which enables the senior citizens aged 60 years or more to avail stream of income
from a lender against the self-acquired house while maintaining the ownership
and staying in the same house respectively. It was introduced in India in the
year 2007 by then Finance Minister P. Chidambaram. . As per the Reverse
Mortgage process, the senior citizens are not required to repay the loan during
their lifetime (Neha Mishra, 2019).
The concept of the Reverse
Mortgage is operational in many developed Western countries and is quite
popular among the senior citizens over there. It also provides a good spirit
among senior citizens and improves their standards of living (BS Web Team, 2018). The
Ministry of the Finance has issued vide notification no- SO 2310(E) dated 30th
September 2008, which notifies the introduction of the Reverse
Mortgage scheme in the year 2008. It provides the Framework under which the
lender will be able to operate the scheme as per the guidelines given by the
National Housing Bank for the operation of the Reserve Mortgage Loan scheme
effectively. The Reverse Mortgage process is known as a new type of contract in
India and is responsible to make up the shortfall that is present in the
pension income of a senior citizen. It also helps the borrowers to have a standard of living in their golden years which
is matching with their earlier years standard of living (Rasmussen,
Megbolugbe & Morgan, 1997).
RM contract has been drafted as
per the guidelines provided by the Governing bodies in India and was finally
prepared by the National Housing Bank. The draft guidelines for Reverse
Mortgage loans in India were prepared by the National Housing Bank.
Working of Reverse Mortgage:
Eligibility:
- The house owners above the age
of 60 years who have the clear title to the house in which they are
residing are eligible to take Reverse
Mortgage Loan and people having less age than 60 years are not liable to take
facilities provided by the Reverse Mortgage scheme (Kaur Brar,
2011); (Howden-Chapman, Signal & Crane, 1999).
- Married couple are eligible as
joint borrowers under the scheme. It says that the spouse will be joined with
the borrower for financial assistance. In
such cases, atleast one of the couple should be minimum 60 years of age and the
spouse’ age should not be less than 50 years.
- The scheme also mentions that
residential property should be free from any encumbrance and must not include
the commercial properties in eligibility criteria under the Reverse Mortgage
Loan scheme.
- Further, the residual life of
residential property should be atleast 20 years and it should be in use by
borrower as his/her permanent primary residence.
Loan Disbursement
- The amount of loan agreed upon
by bank depends on the bank’s valuation of the house/property which in turn is depends on age of borrower,
his life expectancy, age of the property and the interest rates prevailing at
the time(Sehgal, 2007). In respect to this, the maximum loan
amount is up to 60% of the value of the residential property and maximum tenure
of Reverse Mortgage Loan is 20 years.
- The reimbursement of Reverse
Mortgage Loan could be as monthly, quarterly, half yearly and yearly as decided
between borrower and the lender.. It
also may also be in the form of lump sum payment and/or the line of credit .
- Reserve Mortgage Loan could be
used to fund the renovation, expansion, maintenance and Insurance of residential
property, medical emergency, family expenses. The reverse mortgage loan may
supplement pension and any other income
(Atmadip Ray,2014).
The scheme also stipulates the
condition prevailing in the house and determines who can stay in the same house
after the completion of tenure of a Reverse Mortgage.
Settlement of Loan:
The RM Loan becomes due for
repayment on the death of last surviving borrower or in the instance of the
borrower leaves the property and shifts elsewhere. Under such circumstances,
the loan along with interest becomes due for repayment. The bank may recover
the loan through sale of the property mortgaged. The offer may also be given to
the surviving heirs of the elderly for settlement of loan and take complete
possession of the property.
The lenders have limited recourse
to the extent of mortgaged property against which Reverse Mortgage loan has
been taken. All Reverse Mortgage loans are expected to have “no negative
equity” or “non-recourse” guarantee. The borrower at any point of time will not
owe to the lender more than the value of property mortgaged.
Reverse Mortgage Loan are provided by the
Primary lending Institutions {PLIs) viz scheduled bank and Housing Finance
Companies which are registered under the National Housing Bank. To make focus
on major Reverse Mortgage product in India; it mainly includes 23 and 28 FC
that has launched the Reverse Mortgage Loan product. A number of Banks and
financial Institutions are providing Reverse Mortgage loans in India. Saksham
and the Dewan Housing Finance Limited is the first company in India to launch
the Reverse Mortgage product in Mumbai and subsequently in Thane area (Saikat Neogi, 2017). Punjab National
Bank is the first public sector bank to
launch the Reverse Mortgage Loan products- Bhagban . The qualifying amount introduced
by the bank is totally depended on the relay containing the margin of the 20%.
It also includes the Baroda share which was launched by the Bank of Baroda as
per the guidelines provided by the National Housing Board which ensure the
maximum loan amount. It mainly includes the interest and restricts the mortgage
limitation to Rupees 1 crore only which is subject to the margin of 20% as per
the present market value of the property. Another RM Loan worth mentioning is Swabhiman plus which was launched by the
Central Bank of India by the collaboration with Star Union Dai-ichi Life
Insurance Company for the purpose of providing live and strength to the senior
citizens (Goyal, 2014); (Antony, Purwar, Kinra & Moorthy,
2011. The SBI Reverse Mortgage is one of the largest public sector banks that
have joined the Reverse Mortgage club by launching Reverse Mortgage Loan
product by providing a joint loan with loan amount equal to the 90% of the
value of the property (Kaur Brar, 2011).
The main objective of this study is to study the
factors that determine the success or failure of Reverse Mortgage both from borrowers
(senior citizens) and lenders (banks and financial institutions) perspective.. In addition to this, the other objectives are as
follows:
·
To identify the challenges studied in
research for Reverse Mortgage from a borrowers
perspective
·
To identify the challenges studied in
research for Reverse Mortgage from the lenders
perspective
·
To identify various measures studied in
research that help reduce the reverse mortgage risks for borrowers.
Methodology
This study adopts a systematic review of literature on
the construct namely “Reverse Mortgage “Only original peer reviewed English
journal publication were included. To find such papers we used EBSCO, SAGE, and
Google Scholar data bases using key words such as Reverse Mortgage, Risks,
Interest rate, Old age, retirement income, bequest, factors, borrowers, lenders
etc. The search yielded empirical studies, conceptual articles and reviews. The
Meta search yielded 200 articles. After the elimination of duplicate articles,
120 articles were selected for the purpose of classification. The papers were
classified into six categories namely Conceptual
Papers ,Antecedents of factors , Antecedents of Risks , Country wise studies ,
papers stipulating the effect of Govt
Policies ,and studies related to
awareness and perception. 74 articles were selected from different
groups for abstract reading. 60 papers having most relevance to the topic of interest
were finally selected for full paper reading.
The following figure presents the
steps followed to eliminate and select the final articles that were read to
carry out the review.
Figure:
1
Conceptual Papers (8) Antecedents of factors (14) Antecedents of Risks (8) Country wise studies (20) Effect of Govt Policies (8) Awareness and
Perception (16) Abstract Reading (74)
Classification of Articles (74
Articles)
Elimination of Duplication (120
Articles) Meta Search (200 Articles) Full Paper Reading (60)
Huan & Mahoney (2002), define reverse mortgage as an
innovative financial product which enables the senior citizens to convert their
housing equity into cash flow when they need it the most. Senior citizens above
the age of 60 can mortgage the house property with the lending institution. The
borrower at this age is usually not eligible for any other loan but reverse mortgage instrument not only
provides cash flow but also provides the lifetime right to the senior citizens
to stay in their own house. As a result, the Reverse Mortgage scheme has become
an important source of financing the post-retirement life of significant and
fast-growing urban middle-class senior citizens in India. It may be termed as
“house rich but cash poor” phase, because of the insufficient cash inflow after
the retirement.
Chatterjee (2016) defines
Reverse Mortgage (RM) loans as a “hybrid
financial product” that allow homeowners above the age of 60 to borrow against
their property that is the place of primary residence. The borrower can meet
his retirement expenses and continue to live in the house for the rest of his
life without worrying to make repayment of the loan.
Tribunella (2014)
remarks that Reverse Mortgage is an important financial tool which has gained acceptability
among retired individuals who have limited savings and but they have equity
tied up in assets.
Delgadillo et al., (2014)
see increasing market for reverse mortgage loans .The researchers see huge market
potential because of changes in demography having population with longer
life spans, lesser pensions, and presence
of debts and mortgages. The more number
of elderly with housing equity will need to tap their home equity in
retirement.
Ando and Modigliani (1963) , Friedman
(1957) Modigliani and Brumberg (1954 etc support
the consumption smoothening theory. To elaborate, their studies have discussed
that elderly are likely to favor reverse mortgage loans to be able to maintain
their standard of living and pay for their consumption requirements in the
retirement.
Zheng,
Xikun (2016) studied the interest
rate fluctuations and analysed the influence of interest rate on reverse
mortgage loan pricing. Their study suggested that the lenders can introduce
interest-rate ceiling or floors, so that the borrower or the lender can get the
benefits.
Rajagopalan (2007)
in his paper remarked that reverse mortgage helps elderly meet their retirement
expanses by taking a loan which they do not have to pay in their lifetime.
Mohammed,
Sulaiman have used
ReMUIM (Reverse Mortgage Use Intention Model )
to identify
the underlying behavioural factors that can influence potential borrowers willingness to use reverse mortgage as a
source of supplementary income in old age. They have cited various factors such
as social status, bequest motive, awareness about the product, societal influence;
attitude, purchase intention influenced by their belief about opportunities
(availability of reverse mortgage products, desire to age-in-place) resources
and risk averseness or debt averseness etc influence the borrower’s willingness
to borrow reverse mortgage loans.
Mitchell and John
(2004) studied the demographic conditions in
Japan to assess the need and demand for reverse mortgage in the Asian country.
They found that Japan, one of the world’s most developed countries is
experiencing a high aging rate, small size of families due to declining
fertility rate, growth in life expectancy. Reverse Mortgage, in such situations
is ideally suited for aging Japanese to supplement their income post
retirement. The researchers professed that Reverse Mortgage could help the
government in coping with financial strain imposed by population aging on Japanese
economy.
Eschtruth, Sun and
Webb, (2006) find in their study that the
average wealth of households aged 55 to 65 in US has increased substantially
due to appreciation of housing value. Their
study revealed that the interest rates affect the amount of loan that will be
available to borrower as it directly affects the percentage of the value of
property that can be borrowed. As per their study, an average American could
receive only about 50% of their home through Reverse Mortgage at the prevailing
interest rates in the US.
Davidoff and Welke (2004),
in their study selection and moral hazard in reverse mortgage see a positive
correlation between HECM participation and the rate of departure from home.
Participation in HECM is associated with more rapid mobility in both borrowers
and non- borrowers in high appreciation states. They
further suggest that the basic advantageous selection may be challenged by
Moral Hazard risk due to decline in price appreciation.
Their
survey also reveals that single women who opt for reverse mortgage loan are
more likely to leave their place of residence than the observably similar non-borrowing
homeowners.
S Moulton et al (2019)
modelled the reverse mortgage loans against other options of equity borrowing. They
compared the borrowing patterns in the credit constrained areas and non
constrained areas and found that the borrowers in credit constrained areas are
more likely to opt for Housing Equity Mortgage Loan than in non-credit constrained
areas specially during the housing boom.
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Barbara, Megbolugbe, Rasmussen
(1996) explored the effect of Reverse
Mortgage on economic status of elderly women. Their study indicated that a high
proportion of elderly women living alone are attracted to reverse mortgage
loans to supplement their old age income. The reverse mortgage scheme however
has not been completely able to alleviate low income and poverty among elderly
women.
Bishop, Shan (2008) studied
HECM loans in US and found that borrowers in HECM scheme have become younger
over the time and HECM program has the highest termination hazard and couples
have the lowest.
Rasmussen et al.,
(1996) studied the senior citizens motives for
obtaining a Reverse Mortgage. They concluded that “life-cycle motive” and the
“asset management motive” are the tow driving forces behind the borrowing
motives of senior citizens. The aging population opts for reverse mortgage to draw
down wealth in their old age and to to diversify illiquid housing wealth .
Bureau (2012) report studies
that releasing home equity has
become popular since 1970 and 1980. Reverse
Mortgage Loan is provided in various forms in different countries like USA,
Great Britain, Australia, Canada, New Zealand, Japan, and Singapore. The Reverse
Mortgage scheme is particularly famous and successful in the United States
famously known as Home Equity Conversion Mortgage (HECM). India has taken the
concept of Reverse Mortgagee scheme from the United States and customized it as
per the local requirements of the citizens. There are various commercial banks
that offer reverse mortgage loans (RMLs) in India since 2008. A similar product
in the form of convenient builder arrangement is also popular in India especially
for the senior citizens who are facing a cash crunch. The agreement allows the
senior citizens to acquire a proper valuation of their property or enter into
the arrangement with the builder to construct multi-story flat at his property.
The builder usually keeps one floor for himself and builds rest of the floors
for the owner in addition to giving some cash. As a result, the owners are able
to get the correct evaluation of their properties and gain enough capital or
cash for living their retirement life.
Livemint.com
(2007) the reverse Mortgage Loan has enabled senior citizens to afford better
facilities for themselves in their old age. The main purpose of the Reverse Mortgage Loan
is to generate the income for the elderly by providing equity or cash or
capital against their houses.
During the long term
borrowings, the owners receive a monthly premium payment from the lender. As a
result, the loan balance increases at the end of the long term borrowings
because of more creditability of equity degrees over time. Thus, the right loan
balances (advances) are made available to the borrowers (owners). On the other
hand, interest is added to the outstanding loan.. As a result, less incentive
is available to make capital investment or maintain the condition of the
property which allows the senior citizens to get the right value of their
property.
Leviton, (2002), Warshawsky & Zohrabyan, (2016),
throw
light on type and structure of the Reverse Mortgage loans; it includes three
types of the Reverse Mortgage such as a single-purpose Reverse Mortgage, Cost single
purpose and home equity conversion mortgage (HECM). Single-purpose Reverse
Mortgage is offered by the state local and non- profits agencies and considered
as the least expensive process. The state & local government and non-profits
agencies mainly provide reverse mortgage and help the senior citizens to get
the right valuations of their properties. Cost single purpose loan is usually
provided for payment for the home repair or property tax effectively. It also
provides facilities of repair and maintenance items which mainly includes the
release of payments for the conduct of the necessary repairs to the home
property and payment of taxes.
In contrast, in the single purpose Reverse
Mortgage the payment is provided one-time lump sum .The proceeds become due, ,when
he sells home, moves to another primary residence or die. However, if the
borrower stops maintaining the property or homeowner does not pay the insurance
on the property the repayment may be triggered. As a result, it is a limited
option for the home owner to pay less interest for a single-purpose Reverse
Mortgage of the house equity conversion mortgage. Additionally, there is Home
Equity Conversion Mortgage (HECM) federally issued by the department of Housing and Urban Development in
the USA. It is more expensive as compared to the traditional home loan because
it constitutes a high upfront cost. It mainly uses a wide range of reverse
mortgage processes because it carries no income limitation on the maintenance
requirement.
Home Equity Conversion Mortgage
is not considered a Government Loan but it insured by the federal housing
administration. (Austin Quinn, (2017). It is regarded as a part of the mortgage
insurance premium and is responsible for collecting payments at the closing
which is equal to the 2% of the home appraised value. It also collects the annual premium which is
equal to 0.5 standing loan balance and focuses on the property propriety
reverse mortgage. It is privately insured by the mortgage company and is based
on the standard best practices which provide consumer protection. It is
privately insured by the mortgage company and is based on the standard
practices which provide consumer protection effectively. Moreover, in the HCM
program, mandatory evaluation of the proprietary is necessary for the reverse
mortgage process to meet the older homeowner property eligibility for the FHI
finishing and must record that the valuation of the home does not exceed 1
million dollars.
According to Rodda et al. (2000), Caplin & Leahy, (2002), various
risks are associated with the reverse mortgage both from borrower and lenders
perspective..... Mainly includes the cost that is related to the cost of loan
switches. They also pointed complex nature of loan which makes it difficult for
elderly to understand the features of the loan. There is also lack of awareness
amongst elderly about the reverse mortgage loans they suggested addressing all
the problems that increase the issues for the retirees effectively.
Andrew Caplin (2001), in their
paper, has discussed the Reverse Mortgage market, historical perspectives and
problems associated with the Reverse Mortgage. The market scenarios related to
the lending of money are highly based on regulatory directives laid down by the
governing bodies which lay physical and legal obstacle in the spreading of the
reverse mortgage. As a result, it requires high transaction cost which includes
growing volume with respect to the declining trends in the cost. It also
includes the risk of more property evaluation because of maintenance issues,
resulting in a decrease in equity value. It also results in less availability
of equity at the time of emergency because home equity is an important part of
the precautionary saving. Additionally, the homeowner has a stationary use over
the equity as a Reverse Mortgage fund. As a result, the ability to meet the
unforeseen expenses could be seriously hampered which reduces the worth of the
property assessment. It also creates the aversion to debt because there are
various retirees who simply make use of relief and tend to take the loan against
the house so that they do not have spent much for the life saving to the bill.
It also requires low fees paid to the loan originator and provides less
motivation for the aggressive market regarding the product.
Nakajima and Telyukova (2014) used calibrated life-cycle model of retirement to analyse reverse
mortgage. Their model revealed that the average welfare gain from the borrowing
instrument is $885 per homeowner and that the households with low income, poor
wealth and poor health benefit the most from reverse mortgage loans
A
detailed report of CFPB to Congress,
June 2012 stipulated various factors that have contributed to low penetration
of RML in the market. As per their survey, it is not the lack of awareness but
the lack of interest that has affected the acceptance of RML. Various reasons
attributed to lack of interest have been listed as a general suspicion for the product, the product been seen only as a last resort, a desire to own a
mortgage free home , bequest motive ,
general resistance to loans and social stigma attached to borrowing and
mortgage in some societies.
The report also indicated that there is an added risk
to borrowers because of change in their intention to use RML. Initially, the
purpose of the reverse mortgage loan was to enable the home owners to convert
their housing equity into cash to meet their expenses in the old age.
Increasing number of borrowers is however now using RML to repay or service
their existing loans and mortgages. This means that although the borrowers are
able to solve their existing debt problem but it has also restricted their
ability to raise cash at the time of emergences.
The report also suggests that some of the younger ( in
early 60s) borrowers who borrow against their property to increase their cash
flow before downsizing their residential property may be putting their long-term
financial stability at risk by tapping their home equity too early as they are
more likely to outlive the years for which they will be receiving the loan
installments. Some borrowers prefer to take lump sum upfront against mortgage
of their residential property. These borrowers also face the risk of extreme
financial crunch after a few years in the absence of any other sources of
income.
Report further indicates that the borrowers are susceptible
to misleading advertisement due to complex nature of RMLs. Also, RML include different type of upfront and ongoing costs which the
consumers find difficult to understand. Some if these costs may even make the
RMLs costlier than the traditional loans.
AARP Survey (2006) however indicated
that the desire for holding cash has increased amongst the borrowers. The
survey indicated that the prospective Reverse Mortgage borrowers held the
desire to improve their quality of life and hold sufficient cash for
emergencies.
Manning
Greenwood & Kirby (2018) throw light on the risks which are related to the Reverse
Mortgage from the borrower perspective; According to them the reverse mortgage
from the borrower perspective is difficult to understand because it involves a
very complex and confusing process. Thus, the senior citizens who enter into
the reverse mortgage do not fully understand the terms and condition which are
related to the loan. It also makes an adverse impact on senior citizens
workings and living standards. Additionally, the reverse mortgage is a very
expensive process because of its type and implementation process.
Apart from this, the fees
charged for the processing of the Reverse Mortgage process includes payment of
0.5% to 1% from the lender in the form of insurance premium. As a result, the
additional initial cost gets added up while borrowing in a Reverse Mortgage
Loan which is not accepted by the borrowers positively. In addition to this, since
the senior citizens (borrower) are not required to pay the monthly payment on
the reverse mortgage the interest over the advance loan accumulates. It highly
impacts the borrowers in a negative way and restricts them to actively seek the
Reverse Mortgage loan.
The previous loan is also
evaluated on the basis of the calculated table and makes a reverse impact on
the mortgage process. As a result, the compound interest of the home loan is
secured for the borrower. Apart from this, it was examined that Reverse
Mortgage Loan is especially suited for the short term duration for senior
citizens.
Whereas, more risk is
involved during the long term, which makes a negative impact on the prospect of
senior citizens adopting the Reverse Mortgage Loan process effectively. Moreover, the payouts made to the borrowers
are subject to change and also depends on the interest rate and valuation of
the property at least once in 5 years which may decrease the payout.
As a result, the evaluation
of the property rate of interest in terms of the value of the property goes up
and down which makes a negative impact on the motive of the senior citizens.
According to Saurabh Padmakar Balote (2016) there
are various drawbacks in Reverse Mortgage offerings that make this proposition
risky and unattractive for the borrowers. These include Limited payout tenure,
low loan to value ration and uncertainty of payouts.
1. Limited payout tenure: As
per the operational guidelines of National Housing Bank for the Reverse
Mortgage Loans the loan the maximum loan disbursement is 20 years. In case the
borrower or his/her spouse outlives the tenure they may not have adequate money
to support their survival.
2. Loan to Value (LTV) Ratio is Low: the Loan
to Value ratio, in case of Reverse Mortgage Loans, is only 60% which is low
considering higher equity in houses and rate of appreciation of residential
property. It makes reverse Mortgage loan a low income generating option
compared to the value of the asset.
3. Uncertainty of payouts: The lender is
required to carry out the valuation of property at regular intervals which
should be at least once in 5 years. At the same time, there are fluctuations in
Interest rates. Payouts may change as
per the property revaluation and change in rate of interest if the floating
Interest rates are offered. This makes the payouts uncertain for the borrower
as well the lender.
4. Taxation Uncertainty: There is uncertainty on the treatment of
taxation for the borrower. There is lack of clarity whether RM
payment/instalments are treated as income of the borrower. And if it does, what
would be the treatment of Interest on Loan accrued. There is also lack of
certainty as to how capital gains will be treated, especially if those accrue totally or partially to the lender.
Hammond
(1997) cites some issues that pose a hurdle to acceptance of reverse mortgage
by both borrowers and lenders. These include priority of liens,
mortgage-recordation taxes, restrictions on terms and rates of mortgages, limitations
on use of proceeds, and mandatory counselling requirements.
Andrew
Caplin (2001) lists out several psychological and social factors such as
bequest motive, aversion to creation of debt, psychological attachment with
property.
A possible aversion for RML
is strong bequest motive. In most of the societies, especially Indian society,
elder people want to leave behind their property for their children. They may
also fear antagonising their children by committing their property to bank
against financing their old age needs.
According to Chia and Tsui (2005) social dimensions like bequest motive and stigma attached to
mortgage and psychological dimensions like attachment with their homes and reluctance to
mortgage the home are significant obstacles to the success of Reverse Mortgage.
The
bequest motive has been echoed in 1996 study by Dobrof &Moody who suggested that the elderly’s desire for
leaving a legacy actually stems from their basic need for a “sense of
immortality” .They feel that somehow they will live on the memories of their
younger generations.
According to Michelangeli (2010) reverse mortgages benefit
the cash-rich households but may reduce
the welfare of house-rich, cash-poor
households. This may look counter intuitive but if cash-poor households have to
leave their place of residence for health or nay other reason, the high upfront
fees and accumulated interest rates will leave very less value of the house
left for their consumption leaving them poorer than before.
Some
homeowners regard having to take a mortgage as a shame and hence do not tell
anyone except very close relatives, even if they do take the RML. This hinders
the word of mouth publicity of RMLs (Leviton,
2002)
Challenges
Facing the Lenders: Reverse Mortgage
As per Consumer financial Bureau report June 2012, the RML pose different
kinds of challenges to borrowers. Firstly, lenders find it more complicated to
sell and service than traditional mortgages. IN RML, the cash flows and
repayment are uncertain. The repayment is in lump-sum at an uncertain future
date from the sale of property. The value of sale cannot be pre determined.
Further, there are reputational risks involved in foreclosing on senior citizen
in case of tax and insurance defaults.
Saurabh Padmakar Balote, 2016,
Szymanoski, Edward J. Jr (1994), Rajgopalan (2006),
Shiller and Weiss (2000), Singhal, Saket & Jain, Amit (2008 have analyzed
various barriers and risks which are related to the lenders of Reverse Mortgage
Loan.
The Lenders (PLIs) face various
risks such as Longevity Risk, Crossover Risk which is a function of
occupancy risk, mobility risk, mortality risk, interest rate risk, and home appreciation
risk; interest rate risks, early repayment risks, moral hazard risk, litigation
risk) which are related with their reluctance to offer RML.
1. Longevity Risk or Mortality risk: Reverse
Mortgage Loan is not a very attractive product for the lender as the lender has
to provide the payment affront as a lump sum or as instalments for the life of
borrower. The lender can recover the amount only the death or moving out of
borrower as the case may be, the timings of which is uncertain. If the borrower
lives longer than expected, it becomes uncertain for the lender to be able
receive entire loan value along with accrued interest.
2. Cross-Over Risk: There is high risk of the loan value
exceeding the value of property. This is termed as crossover risk. Increased
life expectancy, increased payout due to appreciation in value of property,
fluctuations in Interest rate may lead to the cross over risk. RM is a ‘non-recourse’ loan which necessitates that the
Borrower will never owe more than the net realizable value of their property.
If the loan value exceeds the net realizable value of the property, it is a
loss to the lender.
3. Early
Repayment Risk - The lenders also
face the risk of early repayment by the borrower. The borrower has the option
of prepay the loan at any time during the loan tenure. The lender, however,
will not be allowed to charge any prepayment penalty for the same.
4. Moral
Hazard Risk -Risk of Moral Hazard often makes the RML option unattractive for
lenders. Since the property is mortgaged to the lending institution, the borrower
may lose interest in maintaining the property.
The borrower many be negligent in renewing home insurance or in payment of
property taxes. There is also a chance that the elderly borrower may become
incapable of maintaining the property. This
negligence of property may lead to depreciation in the value of property. This
Moral hazard risk may take many years to accumulate. Moral hazard risk is not
diversifiable. Davidoff Welke (2004), in their study selection and moral
hazard in reverse mortgage have also stressed on the significance of Moral
hazard in house maintenance. The moral hazard risk increases if there is decline
in property appreciation.
5. Interest
Rate risk: The lender receives a lump sum repayment of the RML at the end of
loan tenure. This repayment includes the interest rate that accumulates over
the years. Considering the fact that the borrower is an elderly citizen and
generally averse to risk, he is provided a fixed interest rate equivalent
entitlement. This exposes the lender to risks related with interest rate
fluctuations. If the interest rates move in direction opposite to the
anticipated one, the lender stands to lose.
6. Takeover of Property by Government
Agency: In case of RMLs, lenders have the claim only on the residential
property of the borrower. In case the land is taken over by government for some
development project, it is the lender which stands to lose.
Interest rate
risk on the other hand is not diversifiable unlike the mortality risk. The
lenders usually charge floating interest rates to minimise their loss but the
interest can only be recovered at the time of loan settlement by disposal of
the property.
Property market
risk is also a diversifiable risk if the borrowers are spread across wide
geographical areas.
Further, the literature discusses others risks which cannot be ignored.
There is a risk of Borrower declaring bankruptcy after having borrowed through
RM. There are certain regulatory risks that affect the lenders.
According to Belsky, Case & Smith, (2008, February),
Goetzmann Capli Hangen, Nalebuff Prentice, Rodkin & Skinner, (2003), to
maintain the borrowers maintenance risk as per the borrower and lender
perspective, the maintenance of the
credit insurance against loan payment production approach is necessary. It will
help to mitigate the risk between the borrowers and the lenders.
It mainly includes the
nature of the credit insurance which covers a range of credit products which
are loans mortgage, second mortgage, home equity line of credit and credit
card. It also includes different events which cover the accident, non-repair
issues, and replacement of the personal property and so on. In case of purchase
of a product or a house for sale, approval from Personal Finance Department
regarding the loan application in conjunction with the purchase of a good is to
be done effectively.
It also includes the use of
credit insurance which is tracked under Federal Reserve board since 1977 and
periodically sampled under the random samples of the household to carry credit
insurance in different products.
Reverse Mortgage is a
complex product and advanced age makes it more difficult for senior citizens to
understand this instrument. Lack of literacy may be another reason for elderly
to be reluctant to accept reverse mortgage as a means to sustain themselves in
old age.
The lending
institutions must provide counselling to the prospective borrowers about the
possible impacts to the borrowers due to adverse movements in interest rates
and property price fluctuations . NGOs like Help Age, Dignity Foundation, Indian
Association of Retired Persons (IARP) etc., may also provide consultancy to
senior citizens.
Certain provisions /factors
such as Clarity in tax treatment of RM receipts, accrued interest, capital
gains , Option to refinance in case interest rates decline substantially ,
Protection against lender defaults, legal protection against eviction from
property based on fine print will reduce reluctance on part of borrowers.
Additionally flexibility in withdrawals
will make RML more suitable to borrowers needs.
Ahlstrom, Tumlinson and Lambrew (2004) expounded that linking
reverse mortgage with long term care can address the need
to better prepare the near elderly and elderly for the cost of long-term care. They further
propounded that using a reverse mortgage to purchase long-term care insurance
can help protect peoples’ retirement savings, limit the financial
responsibility of the Federal and State governments, and provide care options
suited to the individual needs people in their declining years.
Ruchi Arora et al studied the behavioural
aspects of senior citizens related to reverse mortgage scheme in India. They
found a very strong case for reverse mortgage due to various factors such as
reducing fertility, increased longitivity, and lack of social security system
in India. In such a scenario, reverse mortgage is expected to
become a significant option to finance post retirement expenses for burgeoning
urban middle class. They, however, found several biases that affect the
attractiveness of reverse mortgage loans. One such bias is conservatism bias
which is apparent in people in India who are accustomed to culture and tradition.
They form an emotional attachment to their houses and have very little desire
to sell or mortgage the property to bank. This is attached to social stigma. Another
bias is mental accounting bias which can be explained by tendency of people in
creating accounts in their minds and keeping assets and liabilities separately.
Elderly do not see house as an effective retirement financing too due to mental
accounting bias. They also found that increasing retirement income is not a
viable option for senior citizens whose priority is leaving estate to heirs.
The phenomenon of aging is
being experienced globally. There is a demographic shift in favour of elderly population
because of improved living standards and
sanitation ;wider access to medical care
leading to increase in life expectancy
.Developing countries are are also experiencing the phenomenon of population aging specially since
these countries have been able to control the death rate but birth rates
continue to remain high. This population aging has however thrown many
challenges in both social and economic domains.
A reverse mortgage is the
type of loan instrument which answers the growing needs of ageing population by
providing them an option to convert the equity locked in the form of housing
assets into cash flow. The facilities provided by Reverse mortgage scheme are
beneficial for the senior citizens in any kind of repayment option of the loan.
The reverse mortgage, in one form or the other has been around for more than
400 years in various countries of Europe. After gaining popularity in USA and
various other countries, it was introduced in India by the finance minister P.
Chidambaram as a solution for the senior citizens to finance their retirement
by lending the house. It was expected to be very successful in India as there
is virtually no presence or very little and insufficient presence of social
security schemes for elderly in India. Various banking and non-banking
institutions are structured reverse mortgage loans like PNB Bhagban; Baroda
shares Housing Board facilities, Central Bank of India and Swabhiman Plus which
offer RMLs for senior citizens. The Reverse Mortgage Loan schemes highly depend
on the discretion of the primary lending Institution and involve the
consideration of different conditions like presence of at least one owner with
above 62 years old or above. This study highlights the various issues which are faced
by the homeowners such as periodical valuation of property, interest rate
fluctuations, complexity of product , fixed and limited tenure , reluctance
of banks to provide loan to name a few.
All these make a negative impact on the motive of the senior citizens and
restrict them from actively participating in the Reverse Mortgage loan process.
The literature also
discussed various issues and complexities faced by the lenders which make them
reluctant to offer reverse Mortgage loan. These include Mortality Risk, Cross
over risk, risk of Moral Hazard, early repayment, interest rate fluctuations,
lack of clarity in taxation etc. Legal, taxation and other regulatory
uncertainties also adversely affect the acceptance of RMLs. Issues faced by
lenders and lack of sufficient support by govt or regulatory policies restricts
the lender from offering reverse mortgage loans. Study also dwelled on focused
on various credit insurance facilities so that the barriers are addressed and
mitigated effectively.
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1.https://files.consumerfinance.gov
› 201206_cfpb_Reverse_Mortgage_Report
