Home loans are a popular financing option in India for various reasons in addition to the most basic one of wanting to own a home. The property represents a valuable asset though an illiquid one. While owning a property ensures that one has sufficiently valuable assets on hand, it also blocks funds required for other purposes be it children’s education or medical emergencies.
In the West, it is popular to use various other options such as refinancing of home loans, reverse mortgages, etc., in order to generate some cash flow using the illiquid property’s value as base.
Reverse mortgage was introduced in India in 2007 but the idea has not caught on. Also, it caters mostly to senior citizens. However, the concept bears a closer look considering the fact that a sizeable portion of the senior citizen population have homes and are strapped for funds during any financial emergency, post retirement. The important distinction between a reverse mortgage and a conventional mortgage is that there are no principal or interest payments required on the home while the borrower occupies the property. The qualifying amount of the loan would depend on the realisable value of residential property after maintaining a margin of 20 per cent.
The maximum amount of the loan is also fixed. Loans are normally extended as a regular fixed monthly payment (10-20 years) or until death of the last surviving spouse. Some banks also offer payment of a lump sum amount. The loan will be recovered only after the death of both the spouses and no loan repayment is required during the lifetime of the borrower.
Settlement of loan, along with accumulated interest, will be met by the proceeds received out of sale of residential property and any surplus will be paid to heirs. The loan becomes due for recovery and payable six months after death of the last surviving spouse. However, the legal heirs of the deceased borrowers will usually be given first option to settle the loan, along with the accumulated interest, without sale of the property.
The scheme has failed in India because of confusion relating to tax treatment. Tax planners argue that it is not yet clear as to whether the monthly payments accruing to the senior citizen after mortgaging the home should be treated as an income and hence taxed, or just be treated as a loan. Another reason for failure has been the opposition from legal heirs to this scheme since it deprives them of a property inheritance. The other option, of course, to use any residual property value is to refinance it. Refinancing can help generate additional funds based on the value of the property and the repayment ability of the borrower. The repayment ability is assessed by the lender based on taxable income and the value of the property is determined by the data relating to the market value and guideline value of the property. Guideline values differ and have no fixed basis of determination. A wide gap also exists between the guideline value and the market value of a given property. As regards the taxable income of the borrower, this is again a variable factor. Income offered may not reflect the true value of earnings. Given these factors, determination of the refinance amount becomes a tough exercise.
Assuming refinance amount is arrived at to the satisfaction of both borrower and lender, the next query would be tax related. Is the interest on refinance claimable on the tax return? Strictly speaking, interest paid on construction or acquisition of a property is claimable on the tax return but some structuring may allow refinance interest also to provide a similar benefit. Using the residual value of a property has not really picked up in India, perhaps because not many people are aware of these financial instruments and their prudent use. Another cultural reason could also be the Indians’ age old aversion to debt and adherence to the “neither a borrower, nor a lender be,” precept.
(G. Karthikeyan is a Coimbatore-based Chartered Accountant)