Annuity mortgage
Before trying to understand what is an annuity mortgage, it is essential to know what is conventionally understood by the word annuity , and how this word is different from what is known as annuity mortgage. In common parlance, annuity implies a contract between an insurance company and an individual. The individual either saves on regular basis under an insurance policy, which fetches him or her, a regular sum after a stipulated number of years.
Alternatively, the individual buys an annuity by paying a lump sum, so that the insurance company manages the funds by investing in various reliable return generating investments. These returns may be fixed or variable. In addition to this income post retirement, annuities offered by insurance companies also have additional features, such as surrender values, withdrawal limits for emergencies, and amount payable at the time of the death of insured.
Annuity mortgage has nothing to do with the annuity contract between an individual and an insurance company. The word annuity in annuity mortgage refers to annual payment towards repayment of a mortgage loan. In addition, the annual payment may, in fact, be amounts being paid or payable per month. These monthly installments are generally equated installments, i.e., they are equal throughout the mortgage loan period, which may be as long as 35 to 40 years for a young, first time mortgage loan taker. Others may be able to obtain mortgage loans for 25 to 30 years. The monthly installment has a component towards mortgage loan repayment, and the balance is towards interest. These components are never stagnant. They vary. Therefore, in the initial stages of the loan, the interest component in these monthly loan repayment installments is higher. And in the later stages, it is the principal component in these installments, which is more.
At times, the borrower may obtain annuity mortgage on interest only basis. This means that the borrower will only be liable towards the interest component on the loan throughout the tenure. The principal component will be paid at the end of the loan term.
The interest rates may be calculated on the annuity mortgage on fixed or variable rates. This is not to be confused with equated monthly installments. Irrespective of whether interest rates are calculated on fixed or variable rates, there is no difference in equated monthly installments. Increase in interest rates decreases the principal component being repaid per month through monthly mortgage loan installments. Effectively, the principal component does not decrease as rapidly as it was planned at the outset. What happens in such cases is that there is an extension of loan term by a few more months or years. Alternatively, the lender may ask the borrower to pay the balance amount at the end of the term, instead of changing the equated monthly installments.
Some annuity mortgages are devised in such a manner that the borrower is required to pay only the interest for a couple of years, and the equated installments start after an agreed moratorium.
Another variation of such mortgages allows the borrower to repay part of the loan after a few years into the loan tenure. Such mortgages are very useful for those individuals who expect some deposits or bonds to mature in between the loan tenure. If these deposits or bonds were withdrawn prematurely, the borrower would be forced to accept lesser interest.
Annuity mortgages have been around for a while. But there is a special type of annuity mortgage called the reverse annuity mortgage or simply reverse mortgage. This type of annuity mortgage allows the borrower to take a regular income from the banker for a long period. At the end of the period, the bank or lender will sell the property, and dues towards regular income and interest thereon provided over the period, will be recovered from the sale proceeds. Effectively, it is quite like receiving annuity from lender for purchase of the real estate property. Conventionally, it is the borrower who pays annuity to lender. In this type of mortgage, the borrower receives the annuity from lender. That is the reason this type of loan is called reverse mortgage.
Reverse mortgage is normally confined to elderly, because their retirement corpus loses value over the years due to inflation. In addition, the income generated from all sources is inadequate to finance their increasing medical and transportation bills. There are no annual increases in remuneration, and however well, a person plans, there are some contingencies that take their toll. This is when reverse mortgage loans come handy. If the elderly do not survive for the entire tenure, then the nominee mentioned by them can repay the outstanding dues and interest, and collect back the property from lender.
As the values of property underlying the reverse mortgage keeps on appreciating, the elderly can also ask for upward revision of their annuities, which the lender may allow after considering the dues, interests, and future payments.
Annuity mortgages are an important tax saving tool as the interest paid on mortgages is allowed as an expense. In addition, such loans give youth an opportunity to purchase a property of their own. The payments made as annuity, if discounted at the rates of inflation during the loan tenure, will effectively be much less than what appears on paper. These are the reasons for popularity of these types of mortgages.
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