Mortgage

Your Money: Why reverse annuity mortgage has few takers

Financial Express - Business News, Stock Market News
Written by Publishing Team

Many lenders have never issued such loans, and others suffer from Many lenders have never issued such loans, and others suffer from “a fear of the unknown.”

By Prashant Das

Tantalus, the son of the great Greek god Zeus, owned all the wealth, but a curse prevented him from eating it. Real estate ownership by the Indian middle class has a similar story. In recent decades, the net worth of the elderly has increased, and a greater part of their wealth has been allocated to real estate even if they do not have the cash to meet their needs.

RAM solution
A reverse annual mortgage (RAM) is an effective tool for breaking a Tantalian penalty. Seniors (60+) citizens are allowed to monetize their home ownership while keeping the roof over their heads equally safe and secure. In a typical RAM contract, the lender disburses the loan over 10-20 years in monthly instalments. Homeowners receive a generous pension-like payment to maintain or improve their living standards. At maturity, the payments stop and accrue with the accrued interest, turning into a lump sum that the homeowner pays to the lender. Most importantly, the regulations protect seniors from eviction and foreclosure until either spouse lives. However, the mass continues to attract attention until the couple passes away. In the end, the lender liquidates the house, claims the remaining balance, and hands the rest over to the rightful heirs.

A study conducted by IIM students in Ahmedabad estimates that nearly 26 million households in India will be eligible for RAM in the next decade. With a ticket size of 25 lakh, the market is valued at 860 billion US dollars. But since 2007, the total number of RAM modules issued in India is only a few hundred.

roadblocks
Many lenders have never issued such loans, and others suffer from “a fear of the unknown.” Some expressed concern about the risks related primarily to the liquidation of assets. Others blamed weak demand. In fact, RAM partially limits the motive of the will: the heirs will be entitled only to the remaining cash left by the lender.

The bettors can pass the RAM payments to the heirs, if the motive is strong. However, a SEBI survey (2015) suggested that less than 10% of respondents consider a ‘will’ an investment. Thus, the lack of demand for RAM is due to a lack of awareness or supply.

way forward
Supply-side concerns are somewhat irrational. The SARFAESI Act (2002), and the Comprehensive IBC of 2015 provide appropriate measures for banks to recover their receivables. Legal risks can be mitigated by installing a preventive administrative infrastructure. The costs incurred by mortgages can be reduced by building an economy of scale. The Reserve Bank of India (RBI) should have clear provisions on transferring the loan to ARC to avoid inheritance related litigation.

Lenders’ risk is financial and relates to uncertainties in (i) asset price growth (ii) depreciation of the asset; and (3) litigation costs. Our simulation model indicates that 15% of these loans may experience a loss and that the intensity of the loss on these loans is on average 30%. However, with appropriate risk measures in place, the returns at the portfolio level match very well with regular mortgage loans. A great deal of risk can be mitigated by contractual wisdom: (1) adequate documentation of heirs (2) conservative permanent value ratio (3) fair but adequate risk premium; and (iv) the administrative infrastructure to monitor the quality of safeguards over time.

RAM is a boon to both borrowers and lenders. India must unlock the potential to further rationalize its real estate markets.

The writer is Assistant Professor of Real Estate (Finance and Accounting), IIM Ahmedabad. Based on the input of a study conducted by Akshay Thakur and Rasika Nashtani, final year MBA students at IIM-A

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