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Is a Reverse Mortgage Right for You?
November 9, 2021 | Posted by: Christopher Chanakos
Reverse mortgages have never been this popular in Canada. With people living longer, pensions disappearing and the cost of living increasing, many homeowners are turning to reverse mortgages in order to support their retirement.
Inquiries about them have doubled between 2016 and 2017, according to HomeEquity Bank’s CHIP Reverse Mortgage, which was, for a time, the only financial institution to offer them nationwide.
And as a wave of baby boomers move towards retirement, competition to serve those who are feeling house-rich and cash-poor is heating up. Equitable Bank became a second option for retirees looking for a reverse mortgage in January when it announced its PATH Home Plan, which is available through mortgage brokers in Alberta, British Columbia and Ontario.
The basic idea of a reverse mortgage is simple. Instead of making payments to build up equity in your home, as you would with a traditional mortgage, you draw down on your home equity and receive payments. You can opt for a lump-sum loan or get a certain amount of cash at regular intervals.
With a reverse mortgage, you generate some extra income and get to stay in your home. In a country where approximately 35% of those approaching retirement has no savings, it sounds like a great solution.
However, there is a downside. Reverse mortgages are expensive. The current interest rate on a five-year fixed-rate loan is 6.49 per cent, almost double what you’d pay with a regular mortgage these days. In addition, there will be less equity left for your kids, grand-kids or anyone else who might inherit your home.
For these reasons a reverse mortgage requires careful consideration.
Drawing on your home equity should not be a retirement plan. However, for the increasing number of house rich seniors with little to no income, it is an attractive alternative.
Here are a few things you should know about reverse mortgages:
Reverse mortgages are only available to Canadians 55 and older who own their home.
The overall amount of the loan is capped at 55 per cent of the value of the house for HomeEquity Bank and 40 per cent for Equitable Bank. The important thing to remember is that you cannot borrow more than your home is worth. Your cap will depend on factors such as your age, your equity stake, the appraised value of your home, where you live and current interest rates. Moreover, your spouse will also need to be over 55. If said spouse is younger than you, you may not be able to borrow as much.
When you take out a reverse mortgage, the interest on your loan comes out of your home equity. For example, if you have a $400,000 home and take out $100,000 at 6.49 per cent over five years, you’d be paying over $37,000 in interest, according to HomeEquity Bank’s online calculator. That means your equity stake in the house would be $137,000 less by the end of the mortgage term.
The lender will continue to charge you interest until the loan is paid in full. In the example above, assuming you don’t want another loan but are unable to repay what you owe at the end of year five, your rate will be reset for another five-year term. In other words, your new rate applies to the full $137,000, not just your original principal of $100,000.
If the house is sold, the reverse mortgage will discharge like any other mortgage: The lender gets what it is owed first, the borrower receives the remainder. The same applies if you die without having moved out. Assuming you have descendants and a will, your survivors will get whatever is left, if anything.
The Pros and Cons to Reverse Mortgages:
Cons:
The interest charges can erode your home equity pretty quickly, leaving less for your children in the future.
It is very difficult to borrow against a property with a reverse mortgage on it.
Current rising interest rates and housing corrections are not favourable conditions for a reverse mortgage. Even if housing prices hold strong, rising interest rates would have a negative impact.
When you do decide to sell your home sometime down the road, you may not be left with insufficient funds to cover things like assisted living accommodations.
Pros:
Although interest rates may be on the rise, your home equity is likely going to continue to rise as well. Even a modest 2% gain in home value per year over 5 years on a $500,000 home would likely mitigate the cost of a $100,000 reverse mortgage. This is especially true in markets like Vancouver and Toronto where many baby boomer’s homes have tripled in value since they were purchased and will likely continue to rise in value.
Even if home values plummet and your home value eventually dips below the amount of your reverse mortgage loan, you will never end up with negative equity. In other words, your heirs will never be left with debt as a result of a reverse mortgage.
Maybe the biggest pro for elderly Canadians is the ability to stay in their homes. After all, they worked their entire lives to buy, and raise, their families in these homes.
If you are considering a reverse mortgage, always speak to a mortgage professional first.