The pros and cons of a Reverse Mortgage

Guest post from Tricia French, MSc, PHEc

A Reverse Mortgage is a means for homeowners to access a portion of the stored value of their home to use today, while still retaining ownership of their home. In effect, converting the equity to cash, which can be received as a lump sum, regular payments, or a combination of the two. The agreement is a “life-term” loan, which is a loan for either the lifetime(s) of the owners or the life of the ownership of the home.

Reverse mortgages are marketed very effectively. The portrayal seems undeniably convincing. Stay in your home. Remain independent. Maintain your financial freedom. Enjoy your money now, you deserve it. Renovate your house. Give your family money. Your home will continue to appreciate in value and offset interest costs and loss of equity.

Advantages:

  • Payments from a reverse mortgage are tax-free income, so income-tested benefits such as OAS and GIS will not be affected.
  • Reverse mortgages do not have to be repaid until you sell your home or you or your surviving partner pass away.
  • The freedom to eliminate monthly payments can be a benefit for stretched budgets.
  • You can repay the loan at any time.
  • If the investment market takes a downturn, a reverse mortgage could fill the gap until your investments stabilize or reach maturity.
  • The amount you owe can never exceed the value of your property.
  • You and your beneficiaries will not be responsible for any shortfall if interest rates increase and housing values drop.
  • Depending on the provider, funds can be received as a lump sum, regular payments or a combination of lump sum and regular payments.
  • Interest paid on the reverse mortgage is tax deductible if the proceeds were used to earn investment income (interest or dividends).

Disadvantages:

  • While your home may continue to appreciate in value and offset some of the interest costs and loss of equity, interest will rapidly accumulate on the amount you borrow.
  • Providers market the benefit of using a reverse mortgage to increase savings by shifting wealth from your home to your investments. This form of leverage adds risk.
  • Due to start-up fees and higher rates of interest, reverse mortgages are more costly than conventional lines of credit or mortgages. Early payment of all or a portion of the amount borrowed could subject you to prepayment penalties. Borrowing against your home will impact the amount available to pass on to your beneficiaries.
  • There are limited options as only two companies in Canada offer reverse mortgages: Canadian Home Income Plan (CHIP) and Seniors Money Canada.
  • Reverse Mortgages can be an expensive way to access some of the value built up in your home. Start-up fees can be significant and interest rates on reverse mortgages are much higher than standard mortgage rates. Start-up fees depend on options selected but typically include an application fee, home appraisal fee, and costs for independent legal advice. Fees can easily reach $2000 to $2500 which is deducted from the principle received.
  • The amount you can borrow through a reverse mortgage varies dramatically based on geographic location, the type of housing you own, your age and gender, and the amount of your current debt.  A reverse mortgage may not be an option depending on these circumstances.

Reverse Mortgage Lines of Credit

Reverse Mortgage Lines of Credit are available at some Credit Unions in British Columbia and Ontario. A reverse mortgage line of credit functions like a reverse mortgage in that no payments are required until you sell your house, or you and your surviving spouse pass away. You may make payments of interest or interest and principal if you wish. The limit on the line of credit is based on similar criteria to the reverse mortgage: property value, geographic location, type of housing, and amount of current debt.

Providers:

Only two companies in Canada offer reverse mortgages: Canadian Home Income Plan (CHIP) and Seniors Money Canada. The Canadian Home Income Plan (CHIP) is a private corporation that has offered reverse mortgages since 1986, and is the leading provider. Seniors Money Canada, a division of Seniors Money International, was introduced to the Canadian Market from New Zealand in August 2007, and expanded offerings to include Western and Atlantic Canada in January 2008. Due to world economic conditions, Seniors Money has ceased accepting new loans. Many mortgage brokers or Accredited Mortgage Professionals (AMP) will provide information and advice regarding reverse mortgage products. Reverse mortgage providers partner with banks, credit unions, mortgage brokers, financial and investment advisors, and other financial professionals who are then compensated for providing client referrals.

As opposed to a standard mortgage, reverse mortgages are a growing debt that consumes the equity in your home. Though the balance, principle borrowed plus accumulated interest, does not need to be repaid until you sell or pass away, it is quietly mounting and can reach a level that your remaining equity is too depleted to allow you consider alternative types of housing, i.e., downsizing. You can run down your equity far faster than you built it. Both providers in Canada expect you to seek and pay for independent legal advice, to ensure you are entering into the agreement freely, that is, without pressure, and that you understand the contract and any potential risks.

Borrowing minimums and maximums vary between providers and are generally based on a percentage of the value of your home. However, the amount you can borrow through a reverse mortgage varies dramatically based on geographic location, the type of housing you own, your age and gender, and the amount of your current debt.

These products are complex and all costs, advantages, and disadvantages should be carefully contemplated within the context of your overall financial plan.

Patricia French is a Financial Counsellor and Professional Human Ecologist specializing in planning with clients under the age of 50. She is an experienced facilitator, pre-retirement educator, and University instructor with the Department of Human Ecology at the University of Alberta teaching in the area of family finance. She is driven to provide clients, participants, and students with key knowledge, skills, and strategies to navigate the often potholed financial road ahead.

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17 Responses to The pros and cons of a Reverse Mortgage

  1. I am absolutely NOT a fan of reverse mortgages; they’re an expensive way to tap your equity. Why not rent out a portion of your home? Borrow against your home? I would advise going to great lengths to avoid a reverse mortgage.

  2. There are pros and cons of the reverse mortgage but it depends on the situation of the person weather he wants to take the mortgage or not and that will make the pros and cons effective to him

  3. Reverse mortgages can be beneficial when used correctly but what amazes is the fact that there are only a few providers in the industry when compared to the conventional mortgage. I guess at the end of the day its because there isn’t a market for “reverse” mortgage backed securities. Getting controlled by hedge funds, pretty sad if you ask me!

    • There’s actually only one company currently offering reverse mortgages – CHIP. The others say due to economic times they are not offering RMs at this time.

  4. Jim, you are absolutely right. We have been getting a few inquiries from clients out in Ontario and the only lender we are able to use is CHIP.

    With prime still at 3% and the economy not recovering, I am getting our clients to go towards the HELOC route due to lower fees (only legal fees for re-registering the mortgage), better interest rate, convenience (online banking to check balances) and because HELOCs are open less a $250 discharge fee, it just make sense to go that route as opposed to the reverse mortgage.

    • Sorry Jim, don’t mean to double post but I forgot to add why we came to this conclusion. We were looking at a few pros/cons.
      With the HELOC:
      Positives – you are able to use up 80% ltv at a lower rate for now (prime + 0.5), no lender fees besides the legal fees and the appraisal. Draw funds at any time up to 80%
      Negatives – Still have to qualify for a mortgage, beacon score has to be over 650 for HELOCs, still have use income to qualify (pension income is totally fine), obligated to make monthly payments
      With the CHIP plan:
      Positives – Credit score/income not as stringent, no obligation for monthly but you are expected to pay a minimum of $1,000 yearly, same appraisal and legal fees.
      Negatives – Higher rate, lowest we are able to offer is the variable rate at 4.75, highest ltv is at 50%, $1,495 CHIP fee (which can be added to mortgage amounts).

      After looking at the pros/cons, we are favoring the HELOC, just wondering what your thoughts are on the subject.

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