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)
http://www.thehindu.com/todays-paper/tp-features/tp-propertyplus/refinancing-vs-reverse-mortgage/article5615593.ece
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