SECURED LOAN BY WAY OF REVERSE MORTGAGE an analysis and some suggestions.

[C.A. DEV KUMAR KOTHARI]

Relevant Links:

Reverse mortgage scheme 2008.

Finance Bill 2008.

Section 47 of the Income Tax act, 1961.

Another article on this website "REVERSE MORTGAGE SCHEME, 2008 - AN OVERVIEW" by Shri Mr. M. GOVINDARAJAN

Terms and conditions of loan and supervision of the same:

The terms and conditions for granting of loan should be on the basis of general monetary policy, trade practices, and as per negotiations between parties. The best authority to regulate them is the Central Bank of any country that is in our country the Reserve Bank Of India. Therefore, even in case of new schemes, like reverse mortgage the primary concerned parties should be the RB, banks and financial institutions and the borrowers. Whether loan is given up front or disbursed in installments, really make no difference so far the character of transaction as secured loan is concerned. It appears that to take credit for so called facilitation from senior citizen the GOI has introduced Reverse Mortage Scheme by un-necessarily involving itself to gain some political milage. A new name 'reverse mortgage loan' has been given under recently announced scheme introduced by the Government which is called "Reverse Mortgage Scheme ", 2008.

Reverse mortgage:

A loan secured on mortgage of residential properties has been introduced as reverse mortgage through The Finance Bill in budget session 2008. After enactment of the proposals and belated notification of the scheme this has become s applicable from 1^st day of April, 2008 vide notification No.93/2008 dated 30.09.2008.Elderly people who have residential house property but have dried up cash flows to meet their day to day affairs are provided benefit of availing loan against property by way of lumpsum and / or EMI

A simple secured loan:

Loan under so called reverse mortgage is also  a simple mortgage secured loan which is not much different from any other secured loan except that certain terms and conditions are different as to type of security, eligible persons  disbursement and recovery of loan. There is no transfer of property from mortgager to lender. In the following table a comparison is made:            

Simple  Mortgage	Reverse Mortgage	Remarks
Loan against mortgage of property means taking loan against mortgage of property.	Loan in reverse mortgage scheme means taking loan against mortgage of property.	In both cases the means and medium of taking loan is same.
Loan can be taken by any person from lending institution or lenders. Every legal person is eligible person for mortgaging the property subject to ownership of property.	Only Eligible persons can take loan from approved lending institutions. In this scheme "eligible person" means (i) any person, being an individual, who is of, a above, the age or sixty years; or (ii) any married couple, if either of the husband or wife is of, or above, the age of sixty years;	In case of reverse mortgage scheme, only certain eligible persons are qualified to obtain the loan and only approved lending institution can provide loan to eligible persons. Where as this is not a criteria of loan in case of general mortgage scheme. In case a lender want to grant loan to any other person also, he can do so under reverse mortgage method also, but it will not be covered by the scheme.
Loan is generally  disbursed fully at the time of taking loan or in two or more installments according to the need of funds of the borrower.	(1) The approved lending institution may disburse the loan to the reverse mortgagor by any one or more of the following modes, namely:-                                                                      (i) periodic payments to be decided mutually between the approved lending institution and the reverse mortgagor; (ii) lump-sum payment in one or more trenches, to the extent that the aggregate of the amount disbursed as lump sum payments does not exceed fifty per cent of the total loan amount sanctioned.	Disbursement of loan is  different in both the cases. However, it is again a matter to be decided between a money lender and the borrower. The scheme should not create a hurdle in flexibility.
The loan can be taken in general mortgage scheme for a longer period than what is prescribed in reverse mortgage scheme. It depends on the desire and decision of lenders.	The loan under reverse mortgage shall not be granted for a period exceeding twenty years from the date of signing the agreement by the reverse mortgagor and the approved lending institution.	At this point also the two schemes are quite different. There is not any legal bar or limitation of period of loan in case of general mortgage scheme in comparison of reverse mortgage scheme.
Capital assets which are to be mortgaged is of any type of capital assets like, shares, residential or commercial property or gold, bullions, bonds and any other assets, which are to be approved by lending institutions.	(d) "Capital asset" means a residential house property which is located in India;	The two schemes are quite different in case of assets which are to be mortgaged. In case of general mortgage scheme, there is no bar of type of capital assets ,which are to be mortgaged.

Loan against mortgage of property- general features: Loan against mortgage of property means taking loan against mortgage of property. Loan can be taken by any person whether artificial or juridical person, company, HUF, association of persons, partnership firms etc. In fact, all legal people are eligible persons for mortgaging the property subject to ownership of property and should be free from any encumbrance. Loan should be disbursed fully at the time of taking loan or in two or three installments .The assets which are mortgaged are fully in control of the mortgager. The mortgager is enjoying the mortgaged property. Only the title deed is submitted to lending institutions till the final repayment of loan or closure of the agreement between mortgager and lender.

Mortgage is of property:

Reverse mortgage is not a different thing so far mortgage is concerned. It is as good as the general mortgage under which mortgager is taken loan from lending institutions and repaying it over a period of time. In case of failure on repayment of loan the lender has the right to sell the property and in case of excess received on sale of property, it should be returned to the mortgager .Here, in this case, all persons are not eligible persons only.

In this scheme "eligible person" means

(i) any person, being an individual, who is of, a above, the age or sixty years; or

(ii) any married couple, if either of the husband or wife is of, or above, the age of sixty years;

There is factually no transfer of capital asset in case of reverse mortgage:

There is no transfer of property even in case of reverse mortgage: Right to sell a property arises only in case of failure to repay the loan at the time of closure of agreement. In that case also the property remains with the owner as excess of receivables on sale of property should be returned back to the owner of the property. The lender is entitled to receive the loan amount with interest, if, any.

Therefore, it appears that the amendment in S.47 was not at all required. The section was amended to clarify that mortgage of property in case of reverse mortgage deal will not be considered as 'transfer' for the purpose of section 47. The amendment is superficial and is likely to promote revenue authorities that in case of mortgage other than those covered by reverse mortgage scheme there should be chargeability of capital gains.

 

Analysis of reverse mortgage scheme:

The preamble and the scheme are reproduced below with highlights for purpose of  understanding:

 NOTIFICATION NO. 93/2008, DATED 30-9-2008

In exercise of the powers conferred by clause (xvi) of section 47 of the Income-tax Act, 1961 (43 of 1961), the Centre! Government hereby makes the following scheme, namely: -

Provisions of scheme with high lights	Remarks
Short title, commencement and application (I)    This scheme may be called the Reverse Mortgage Scheme, 2008.
(2)  It shall be deemed to have come into force from the 1" day of April, 2008.	will apply from assessment year 2008-09  that is previous year ended on 31.03.2008
(3)  Save as otherwise provided  in the Scheme, it shall be applicable to all eligible persons.
2. Definitions.- In this Scheme, unless the context otherwise requires, -
(a) "Act" means the Income-tax Act, 1961 (43 of 1961);
(b) "approved lending institution" means - (i) National Housing Bank established under section 3 of the National Housing Bank Act, 1987 (53 of 1987); (ii) a scheduled bank included in the second schedule to the Reserve Bank of India Act, 1934; or (iii) a housing finance company registered with the National Housing Bank:	NHB   Scheduled Banks Housing Finance Co.
(c) "Board" means the Central Board of Direct Taxes constituted under the Central Boards of Revenue Act, 1963 (54 of 1963V)	CBDT
(d) "Capital asset" means a residential house property which is located in India;	Only residential buildings in India will qualify.
(e) "eligible person" means (i) any person, being an individual, who is of, a above, the age or sixty years; or (ii) any married couple, if either of the husband or wife is of, or above, the age of sixty years;	Only individuals of above sixty years of age are covered. However, in case of married couple if either of spouse is above sixty years, then such married couple will be considered as a an eligible person.  Therefore, in such cases it appears that the loan has to be obtained in joint name, if the owner is not above sixty five years of age.
(f)  "Reverse Mortgage" means mortgage of a capital asset by an eligible person against a loan obtained by him from an approved lending institution;	It is just like any other mortgage but scope is restricted to approved lending institutions.
(g) "reverse mortgagor" means the eligible person who has mortgaged the capital asset for the purpose of obtaining loan;	The mortgagor in this scheme is also in similar position as in case of any other mortgage.
(h) "reverse mortgage transaction" means a transaction in which the loan may be disbursed to the reverse mortgagor but does not include transaction of sale, or disposal, of the property for settlement of the loan;	This is also similar in case of any other mortgage so far provisions of I.T.Act are concerned.
(i) All other words and expressions used herein, but not defined and defined in the Act, shall have the meanings respectively assigned to them in the Act.	Meaning of other words shall be as per I.T.Act.
3. Application and processing for reverse mortgage transaction.-(1) Any eligible person may enter into a reverse mortgage transaction by applying in writing to the approved lending institution, if the capital asset, being mortgaged, is: (i) owned by him; and (ii) free from any encumbrances.	The property should be owned and free from encumbrance that means it should also not be tenanted. Because tenancy is considered an encumbrance and even in case of normal mortgage banks and FI's do not want to give loan against tenanted property. They may extend a loan by way of securitization of rent receivables.
(2) The application under sub-rule. (I) shall be processed by the approved lending institution and for this purpose the institution may charge nominal amount as processing fees.	What is nominal processing fees is not prescribed.
4. Sanction of reverse mortgage loan.- (l) The approved lending institution, before taking mortgage of capital asset and before disbursing any loan under reverse mortgage, shall- (a)  enter into a loan agreement in writing with the reverse mortgagor; and (b) obtain and maintain the following particulars from the reverse mortgagor, namely:- (i) Name and address of the owner of the capital asset; (ii) Permanent Account Number of the owner of the capital asset; (iii) Total area, including built up or covered area, of the capital asset; (iv) Cost of acquisition and the year of acquisition of the capital asset; (v) Cost of improvement and the year of improvement of the capital asset; (vi) Name, address and Permanent Account Number of all the legal heirs and estate of the owner of the capital asset; (vii) A copy of the registered will of the owner of the capital asset including any changes made therein during the currency of the term of the loan.	These are normal requirement and records and documentation in case of loans granted against  security of properties owned by an individual or couple. The additional documents required are  details of legal heirs and estate and registered will. It appears that a registered will is essential because the words, 'if any' are not used.
5. Disbursement of loan.- (1) The approved lending institution may disburse the loan to the reverse mortgagor by any one or more of the following modes, namely:- (i) periodic payments to be decided mutually between the approved lending institution and the reverse mortgagor; (ii) lump-sum payment in one or more trenches, to the extent that the aggregate of the amount disbursed as lump sum payments does not exceed fifty per cent of the total loan amount sanctioned.	The manner of disbursement of  loan is different. The purpose of such loans is to provide  regular inflow of funds to aged people. Therefore monthly disbursement is preferred one.  However, the scheme provide for flexibility  and it can be  a be mix of periodic payment and/ or lump sum payments. At least 50% of loan shall be by way of periodic payment like monthly installment or quarterly installment as may be agreed.
6.Period of reverse mortgage loan.- The loan under reverse mortgage shall not be granted for a period exceeding twenty years from the date of signing the agreement by the reverse mortgagor and the approved lending institution.	The initial tenure of loan will not be more than twenty years. However, it is desirable to provide for a higher tenure and it should be till death of both  the  borrowers (couple). Because at age of eighty years, it will be very difficult to manage affairs and obtain new loan. Suppose a couple has taken a loan. Husband is sixty five  years old  and wife is of fifty nine  years. After twenty years the husband will be eighty five years old and wife will be seventy nine years old. At such an age there should not be discontinuation of regular flow of funds by way of EMI of loan granted. Therefore, the disbursement of loan by way of EMI should continue till the death of both the borrowers.
7. Repayment of loan.- The reverse mortgagor, or his legal heirs or estate, shall be liable for repayment of the principal amount of loan along with the interest to the approved lending institution at the time of foreclosure of the loan agreement.	This is usual terms in any loan.

This scheme is mainly came into force for old aged person who has capital assets but could not maintain the same due to unavailability or insufficiency of the recurring income.

An analysis of the main features of the said scheme is as follows:-

Only elderly people will be benefitted to secure a regular flow of funds by way of EMI of loan .The mortgager is free to use the loan amount during his lifetime in any manner he like. The loan can be repaid after death or at the time of closure of loan account. Only in case of need property can be sold, if repayment is not possible by other means by the borrower himself or his legal heirs. In case of death of borrower, legal heirs or estate of the mortgager is bound to repay the loan amount or the lending institutions can recover the same from sale of mortgaged property, if it is not repaid otherwise. Surplus , if any will belong to the borrower.

It is not a case of  transfer of capital assets as in case of sale. Therefore, the borrower is not required to pay capital gain tax. It is only mortgage of capital assets to obtain loan. In the  income Tax Act, it is specifically provided that  nothing contained in section 45 shall apply to the following transfers :—

[(xvi) Any transfer of a capital asset in a transaction of reverse mortgage under a scheme made and notified by the Central Government.]

  This clause was inserted by the Finance Act, 2008; w.e.f. 1-4-2008.It is not a transfer of                 capital assets as in case of sale.

Therefore, elderly people are saved from otherwise likely demand of capital gain tax. This appears to be a comfort given to elderly people to save them from litigation. However, a clarification is desirable that in case of other mortgages also S. 45 is not attracted so as to make the loan received as sale proceed of property mortgaged.

From the point of view of Banks and FI (money lenders) :

This scheme is beneficial to approved lending institutions also as loan is fully secured by mortgage of capital assets. An insurance for such loan is also desirable to secure money lenders against steep fall in property between the period of date of grant of  loan and death of borrowers.

In case, 20 years has passed from the date of the agreement and the death of the mortgager has not occurred, loan is repayable by mortgager himself or it can be recovered by lending institutions from sale of the said property. This is not justified because at very old age it would be not proper for bank to discontinue EMI and ask the older people to repay the loan or vacate the house in even of sale of mortgaged property. Suppose a person has taken loan at age of 70 years, 20 years completes when he is of the age of 90 years, at such age it would be more difficult for elderly person to re-arrange his financial affairs, in case he is asked to repay loan or his residential property is sold by bank. This sort of action will be totally against the purpose of the loan to elderly people. Therefore, it is desirable that the loan should continue by way of EMI till death of borrower and / or his spouse which ever is late.

Concession in charges is desirable:

Banks and FI's and other companies who take deposits, pay higher rate of interest on deposits from senior citizens, Similarly to discharge  social obligations the money lender should not charge excessively as loan processing fees, interest and foreclosure charges etc. from elderly persons. In fact there should be complete or major relaxation.

Suggestions:

Other properties:

We find that a balanced person who wisely invest has investment in his residential property only to the extent of about 15-20% of investments. Therefore, loan should also be extended against vacant land, office buildings, gold, silver, jewellery, financial instruments etc. apparently there is no justification of restricting the benefits of the scheme only in respect of residential properties.

Loan by other parties: Loan by individuals or firms can also be covered so that in case of urgent need an old person can obtain loan from his friend, relative or neighbor.

Tenure of loan should be till death of last surviving borrower.

Facility of prepayment should be allowed, after notice of say three months and without any pre-closure charges.

Properties under charge or mortgage should also be made eligible for reverse mortgage so that the money lender can extend loan under a second charge during existing loan which is likely to be repaid within some short period or the loan amount is small in comparison to the value of asset.

There should be concessional rate of interest. In view of lack of social financial security provided by the Government the GOI can extend a subsidy of interest.

Reverse mortgage for other persons for short to medium duration:

Many times we find that younger persons have also property acquired by way of inheritance or gifts. Some times property is own acquired during initial period of earning say by the age of 45-50 years. However, for some reasons, like illness, incapacity or being out of job the person is not able to meet his cash out flow requirements. Some times it is seen that due to financial difficulties of tenants, or persons with whom money was invested the cash inflow of a person are temporarily dried up and he faces difficulty in meeting cash out flow obligations. In such circumstances also reverse mortgage for short duration of say 3-5 years can be extended so that such person are not forced to sell property.  

Other article on the subject

The readers may read another article titled "REVERSE MORTGAGE SCHEME, 2008 - AN OVERVIEW" by Shri Mr. M. GOVINDARAJAN which provide insight into some important procedural aspects of reverse mortgage.

Discussions to this article

[K.Ashok Reddy]

Dear sir, Your article is very suggestive and useful. 1)In the explanation of provision under section 2(e) i.e. definition of "eligible person" it was mentioned that the scheme is elegible for spouse as joint owners if the owner is not above sixty five years. Please clarify why owner cannot be eligible for scheme if he is over sixty five years? 2)My humble suggestions are that: a)this scheme is for the welfare of senior citizens facing the problem of receiving regular income. So only those senior citizens who have only one residential house shall be made eligible for the scheme. b) Interest on Fixed Deposits to senior citizens is generally 1% more than the normal rates. Here the reverse mortgagor can take the amount in trenches and deposit it in the Fixed Deposits of the banks or financial institutions to avail arbitrage facilities. So either monthly payment(EMI) should make mandatory or the interest rate should be more than the interest rate available on deposits for senior citizen. c) The maximum amount the reverse mortgagor is eligible for should have been specified in the scheme. It cannot be calculated based on cost of acquisition and improvements only. Otherwise it may end in sub prime crisis prevailing in US now. d) The lending authority should be those institutions whic are regulated by RBI. If neighours or freinds lend then it violates the provisions of Banking Regulation Act. e)The compulsory writing of will at the time of applying for loan is unnecessary and may lead to family disputes. f)It is difficult to keep valuing the capital assets other than residential building by the lending authorities and fluctuations leads to revise the EMI or call for margin money which will be difficult for reverse mortgagors. So reverse mortgage of residential property is more appropriate. With Best Regards Ashok