REVERSE MORTGAGE- A STEP FORWARD

In very simple words, mortgage is a transaction where a mortgagor takes a loan from a mortgagee, against a security. Thus, we can say that a mortgage is a transfer by way of security. Unlike other transfers, such as sale, lease, exchange or gift, a mortgage has no independent existence of its own. There can be no mortgage without a debt. The security provided is an immovable property. A property can be mortgaged in any of the following ways:-
1. Simple Mortgage.
2. Mortgage by Conditional Sale.
3. Usufructuary Mortgage.
4. Mortgage by Deposit of Title of Deeds.
5. English Mortgage.
6. Anomalous Mortgage (which is a combination of any two of the above).

1. Simple Mortgage: When the possession of the mortgaged property is not transferred from mortgagor to the mortgagee. If the mortgagor fails to repay the loan, the mortgagee has the right to sell the property and recover the loan from the sale amount.

2. Conditional Sale: Here the mortgagor apparently sells the property to the mortgagee subject to certain condition. The condition may be either of the following:
a. On failure to repay the mortgage money before a certain date the sale shall become absolute, or
b. On such repayment of mortgage money the sale shall become invalid, or
c. On such repayment the mortgagee shall retransfer the property.

3. Usufructuary Mortgage: In this type of mortgage, the possession of the mortgaged property is transferred to the mortgagee. He receives the income from the property, eg. rent, profit etc, until the repayment of the loan. The title deeds remain with the owner.

4. Mortgage By Deposit Of Title Deeds: Here, the mortgagor delivers the title document of the property to the mortgagee with an intention to create a security thereon. This mortgage can be entered into only in the towns of Chennai, Kolkota, Mumbai or any other town, as notified by the State Government in the official gazette.

5. English Mortgage:
a. The mortgagor transfers the property absolutely to the mortgagee.
b. The mortgagor binds himself to repay the borrowed money before a certain date.
c. Such transfer is subject to the condition that the mortgagee will retransfer the property on repayment before the agreed date.

And reverse mortgage is a new addition to these types of mortgage. Reverse mortgages are available in Ireland, United Kingdom, Australia, the U.S. and other countries in various forms. "Life loan" (Irish/UK term for a reverse mortgage) programs are very similar to U.S. reverse mortgages. In India it’s relatively a new kind of mortgage, though in other parts of world this type of mortgage has been in use for quite a few decades now.

Reverse Mortgages
Reverse mortgages have been popular since the Roman Empire – literally means - "loans until death". Reverse mortgages have effectively been around since Roman times in the form of usufruct.
Usufruct is the legal right to use and derive profit or benefit from property that belongs to another person, as long as the property is not damaged. In many legal systems of property, buyers of property may only purchase the usufruct of the property.

This form of mortgages is aptly named because the payment stream is “reversed.” Instead of making monthly payments to a lender, as with a regular mortgage, a lender makes payments to the borrower. Unlike a regular mortgage, the borrower can continue to stay in his mortgaged home during his entire life span without any fear of eviction even after the tenure expires. Reverse mortgages can be secured by either urban or rural property. The amount of the loan available will depend on the borrower’s age and the value of his equity.

It is essentially a loan given to senior citizens by converting the equity in a house property into an income stream. The scheme involves the borrowers (senior citizens) pledging their house property to a lender (scheduled bank or HFC) in return for a lump sum or periodic payments spread over the borrower’s lifetime. The home owner is not obliged to repay the loan during his lifetime. On his death or leaving the house permanently, the loan is repaid along with accumulated interest, through sale of the house property. Any excess amount will be remitted to the borrower or his heirs.

The lumpsum or periodic payments can be utilized by the borrower as per his needs but not for speculative purposes. After the death of the borrower and the borrower’s spouse, the housing company sells the property to recover the amount paid out along with interest at a rate similar to interest on housing loans. If the owners of the house live for a longer period, the sum that the heir will have to pay would be bigger as the interest amount will go up. But, if he did not survive even to claim the amount for entire period that was agreed for, the repayment amount due to his heir will be smaller. Ownership title of the house making it all the more popular among Indians who have a natural instinct for own home.

However, on the flip side, traditional joint family system, stronger bequeath motive and widespread undervaluation of real estate properties involving unaccounted money, tax evasion and benami holdings can be major deterrents for the scheme to take off.

How does the reverse mortgage scheme works?
Under a reverse mortgage, the real estate to be mortgaged has already been purchased and any financial charges on title to it have been discharged. The borrower is not expected to make periodic payments, or any payments, until the loan comes due. For the lender, the value of the mortgaged property is paramount; for the borrower, the loan is obtained to supplement income or to enable purchases of assets other than the mortgaged property. Eligibility limits on reverse mortgages are much less stringent that traditional forward mortgages.

Outside of homeownership, the borrower must be at least sixty years of age. Given the importance of the value of the reverse mortgage borrower’s property, reverse mortgage lenders require that potential borrowers obtain an appraisal of their property. The potential borrower must pay for this appraisal. The cost of the appraisal should be borne in mind by borrowers; it will form a non-interest charge that should be factored into determining the overall cost of borrowing under a reverse mortgage. Some reverse mortgage lenders require borrowers to retain independent legal representation for the reverse mortgage transaction. Others require borrowers to provide a certificate of independent legal advice as one of the closing documents for the loan.

Reverse mortgage lenders insist on having the first mortgage on title to the borrower’s property. If the borrower’s title is encumbered by other financial charges, then the borrower will be obliged to use part of the reverse mortgage proceeds, or other funds, to pay out and discharge these other charges.

Difference between a Traditional Mortgage and Reverse Mortgage
Contrasting Reverse Mortgage From Traditional Mortgages
Item Reverse Mortgage Traditional Mortgage
Purpose of loan To release the equity in the home and use the proceeds to live a more comfortable, stress-free, retirement To purchase or refinance a home
Before loan closing, Substantial equity in the home No or little equity in the home
At loan closing, Owe very little and have substantial equity Owe a lot, and have little equity
While the loan is outstanding, You receive payments from the lender

Loan balance rises

Equity declines You make payments to the lender

Loan balance goes down

Equity grows
At the end Owe whatever amount was borrowed, plus accrued interest

Have much less, little, or no equity Owe nothing

Have Substantial Equity
Final analysis Rising Debt-Falling Equity Loan Program Falling Debt-Rising Equity Loan Product


Taxation Issues
In the context of the introduction of the Reverse Mortgage scheme, it was necessary to resolve the tax issues arising there-from. The first issue was whether mortgage of property for obtaining a loan under the reverse mortgage scheme is a transfer within the meaning of the Income-tax Act, 1961 (“Income Tax Act”) thereby giving rise to capital gains. Section 2(47) of the Income-tax Act provides an inclusive definition of ‘transfer’. Further, ‘transfer’ within the meaning of the Transfer of Property Act, 1882 (‘Transfer of Property Act”) includes some types of mortgage. Therefore, a mortgage of property, in certain cases, is a transfer within the meaning of section 2(47) of the Income-tax Act. Consequently, any gain arising upon mortgage of a property may give rise to capital gains under section 45 of the Income-tax Act. However, in the context of a reverse mortgage, the intention is to secure a stream of cash flow against the mortgage of a residential house and not to alienate the property.

A new clause (xvi) in section 47 of the Income-tax Act, has been subsequently inserted to provide that any transfer of a capital asset in a transaction of reverse mortgage under a scheme made and notified by the Central Government shall not be regarded as a transfer.

The second issue was whether the loan, either in lump sum or in instalment, received under a reverse mortgage scheme amounts to income and whether the receipt of such loan is in the nature of a capital receipt. As a consequence Section 10 of the Income tax Act, has been amended to provide that any amount received by an individual as a loan, either in lump-sum or in installment, in a transaction of reverse mortgage referred to in clause (xvi) of Section 47 of the Income-tax Act shall not be included in total income. [under Section 10 (43)]

Therefore a borrower, under a reverse mortgage scheme, shall, however, be liable to income tax (in the nature of tax on capital gains) only at the point of alienation of the mortgaged property by the mortgagee for the purposes of recovering the loan.