Reverse mortgages – understand the facts

I’m always fascinated when misconceptions surround a financial product. It seems as if something that can make exciting or controversial cocktail conversation becomes treated as fact, especially if it could potentially impact our money. One such financial product is the reverse mortgage. I have to admit that I myself have been guilty of judging it negatively in the past. In truth, reverse mortgages in Canada can deliver genuine benefits, for someone in the right financial circumstances. If you’re over 55, retired or nearing retirement, and want to access the equity in your home, this is a product you should learn about.

How does a Canadian reverse mortgage work?

A reverse mortgage is not too different from a regular mortgage. You’re borrowing money using your home as collateral, and the mortgage lender charges you interest. You choose a term during which the interest rate is locked in – 6 months, 1, 3 or 5 years – or you can choose a variable rate that fluctuates with the prime rate.

As with a regular mortgage, you continue to live in and keep ownership of your own home. No, the bank does NOT own your home! The mortgage simply allows you to free up the equity in your home to fund other expenditures.

The main difference? You don’t have a payment schedule set up to repay the money. You never need to make a payment. Instead, the amount you owe accumulates interest over time. When the loan is repaid, you are responsible to pay back both the amount you borrowed and the accumulated interest.

The facts about reverse mortgages

• The maximum amount allowed is around 50% of the value of the home.
• The actual amount you qualify for is based on the age of the homeowners, the property value and geographic location of the home.
• To qualify, the homeowner(s) must both be at least 55. The older the homeowners are, the more they qualify for.

Getting the money

• You can receive the money in one or several lump sums, or regular instalments. You only pay interest on the money actually advanced to you.
• You choose what to spend the money on – home renovations, purchasing an annuity or other investments, travel, home care, and so on.
• The money received is not taxable income, so Old Age Security or Guaranteed Income Supplement government benefits are not clawed back.

Paying it back

• The reverse mortgage does not have to be repaid until the home is sold or the borrowers pass away. Because of this, there is no credit check and no need to prove you have income to qualify.
• The lender guarantees that you or your estate will never owe more than the home’s current market value. In fact, because your home tends to increase in value over time, in the majority of the time there is still substantial equity remaining after the reverse mortgage is paid off.
• If you like, you can make minimal payments toward the mortgage, or you can make an annual lump sum payment of up to 10% toward the mortgage. Whether you do this is up to you.

What’s the catch?

Here are some considerations to take into account when deciding whether this product makes sense for you or an older relative:

The interest rates on reverse mortgages are higher than on a mortgage with a regular repayment schedule. At the time of this writing, the 6 month rate is 3.99%, and the 1, 3 and 5 year are 4.95%, 4.99%, and 5.79% respectively.

There are up-front costs.  Compared to getting a regular mortgage, they are not exorbitant, but you should be aware of them.  You may need to pay for a home appraisal – typically $250-400. You also need to obtain independent legal advice, so you need to pay the lawyer their fee – likely $500-700. And finally, the lender charges $900 – $1,495 to register the mortgage, and for closing and administrative costs. This can be deducted directly from the amount you advance from the reverse mortgage.

Your mortgage debt increases, so if you are counting on using the funds from your home to pay for an assisted living facility or retirement residence down the road, you may have less money available to you than if you were to sell the home now. The lender can show you how this number looks so that you can make an informed decision.

There may be penalties to pay off the reverse mortgage early. This is where the independent legal advice comes in – you’ll want your lawyer to walk you through the agreement so you fully understand all the fine print.

What about alternatives?

If you want to access the equity in your home to finance your retirement, you have several options. Selling your home, or staying in your home and setting up a Home Equity Line of Credit for use when needed, are the two main solutions. You can take a look at an earlier article I wrote exploring these other retirement options in more detail.

The key? Plan, plan, plan.

Get in touch as early as possible to find out more. I can help you make an informed decision on the option that works best for your unique situation.

Photo credit: [c] Yulia Gapeenko for vecteezy.com