Your money: why reverse annuity mortgages have few takers
By Prashant Das
Tantalus, the son of the mighty Greek god Zeus, possessed all wealth, but a curse forbade him to consume it. Property ownership by the Indian middle class has a similar history. In recent decades, the net worth of seniors has increased and more of their wealth is allocated to real estate, even though they may not have the cash to meet their needs.
RAM as a solution
The Reverse Annuity Mortgage (RAM) is an effective tool to break tantalum punishment. It allows seniors (60+) to convert their property to cash while keeping the roof over their heads just as safe and secure. In a typical RAM contract, a lender pays the loan over 10 to 20 years in monthly installments. Homeowners receive a decent payment, similar to a pension, to maintain or improve their standard of living. At maturity, the payments stop and clubbed with the accrued interest, turn into a lump sum payable by the owner to the lender. It’s important to note that regulations protect seniors from eviction and foreclosure until one of the two spouses is alive. The lump sum, however, continues to generate interest until the death of both spouses. Eventually, the lender liquidates the house, claims the unpaid balance, and delivers the rest to the legal heirs.
A study by IIM students in Ahmedabad estimates that nearly 26 million households in India will be eligible for AMR over the next decade. With a note size of 25 lakh, the market is worth $ 860 billion. But since 2007, the total number of RAMs issued in India is only a few hundred.
Many lenders have never made such loans, and others suffer from âfear of the unknownâ. Some were concerned about the risks, mainly related to the liquidation of assets. Others blamed it on low demand. Indeed, RAM partially limits the reason for the bequest: the heirs will only be entitled to the residual cash left by the lender.
Mortgages can pass on RAM payments to heirs if the motivation is strong. However, a SEBI survey (2015) suggested that less than 10% of respondents consider the âbequestâ as their motivation for investing. Thus, the lack of demand for RAM is caused by a lack of awareness or supply.
The path to follow
The concerns on the supply side are somewhat irrational. The SARFAESI law (2002) and the global IBC of 2015 provide for adequate measures allowing banks to recover their contributions. Legal risks can be mitigated by installing a preventive administrative infrastructure. The costs passed on to mortgagors can be minimized by creating an economy of scale. The RBI should have clear arrangements for transferring the loan to CRAs in order to avoid heir litigation.
Lender risks are financial and relate to uncertainties about (1) the growth in the price of assets (2) the depreciation of the asset; and (3) foreclosure / litigation costs. Our simulation model suggests that 15% of these loans may experience losses and that the severity of the losses of these loans is on average 30%. Yet, with the right risk measures, returns at the portfolio level match very well with those on regular mortgages. A large part of the risks can be mitigated by contractual prudence: (1) adequate documentation of the heirs (2) conservative LTV ratio (3) fair but adequate risk premium; and (4) administrative infrastructure to monitor the quality of collateral over time.
RAM is a boon for both borrowers and lenders. India must unleash the potential to further streamline real estate markets.
The writer is associate professor of real estate (finance and accounting), IIM Ahmedabad. Based on research contributions from Akshay Thakur and Rasika Nishtane, final year MBA students at IIM-A