By Prashant Das
Tantalus, the son of mighty Greek god Zeus had all the wealth, but a curse forbade him from consuming it. Real estate ownership by Indian middle-class has a similar story. In recent decades, the net worth of senior citizens has increased, and a larger portion of their wealth is allocated to real estate even as they may not have the liquid cash to meet their needs.
RAM as a solution
Reverse annuity mortgage (RAM) is an effective tool to break the Tantalian punishment. It allows senior (60+) citizens to convert their homeownership into cash but keep the roof over their head just as safe and secure. In a typical RAM contract, a lender disburses the loan over 10-20 years in monthly instalments. Homeowners receive a dignified, pension-like payment to sustain, or enhance their living standards. At maturity, the payments stop and clubbed with the accumulated interest, turn into a lumpsum payable by homeowner to lender. Importantly, regulation protects senior citizens from eviction and foreclosure until any of the two spouses is alive. The lumpsum, however, continues to attract interest until both the spouses pass away. Eventually, the lender liquidates the home, claims the outstanding balance, and hands over the rest to legal heirs.
A study by IIM Ahmedabad students 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 worth US$860 billion. But since 2007, the total number of RAMs issued in India is just a few hundred.
Many lenders never issued such loans, and others suffer from the “fear of the unknown.” Some were concerned about risks, primarily related to the asset liquidation. Others blamed it on poor demand. Indeed, RAM partially limits the bequest motive: The heirs will only be entitled to the residual cash left over by the lender.
Mortgagors can pass on the RAM payments to the heirs, if the motivation is strong. However, a SEBI survey (2015) suggested that less than 10% respondents consider “bequest” as their investment motive. Thus, the lack of demand for RAM is caused by lack of awareness or supply.
The way forward
The supply side concerns are somewhat irrational. The SARFAESI Act (2002), and the overarching IBC of 2015 provide adequate measures for banks to recuperate their dues. Legal risks can be mitigated by installing pre-emptive administrative infrastructure. The costs passed on to the mortgagors can be minimised by building an economy of scale. RBI must have clear provisions for transferring the loan to ARCs to avoid heir-related litigation.
The lenders’ risks are financial and relate to the uncertainties in (1) asset price growth (2) depreciation in the asset; and (3) foreclosure/litigation costs. Our simulation model suggests that 15% of such loans may run into loss and the loss-severity in such loans averages at 30%. Yet, with adequate risk measures, the returns at the portfolio level very well match those on regular mortgage loans. A great deal of the risks can be mitigated by contractual prudence: (1) adequate documentation of heirs (2) conservative LTV ratio (3) fair but adequate premium for risks; and (4) administrative infrastructure to monitor the collateral quality over time.
RAM is a boon both for borrowers and lenders. India must unlock the potential to further rationalise the real estate markets.
The writer is associate professor of Real Estate (Finance & Accounting), IIM Ahmedabad. Based on inputs from a study by Akshay Thakur and Rasika Nishtane, final-year MBA students at IIM-A