As you enter retirement, it’s common to start looking for ways to supplement your income and make the most of your assets. One option that many seniors are now considering is a reverse mortgage. A reverse mortgage allows you to access the equity in your home without having to sell or move out. However, it's important to ask the right questions before taking out a reverse mortgage.
In this article, we'll explore 8 key questions that you should ask to determine if a reverse mortgage is right for you.
What is a Reverse Mortgage?
A reverse mortgage is a loan that allows homeowners aged 55 or older to access the equity in their homes without having to sell or move out. The loan is secured by the home and the borrower does not have to make any payments until the home is sold or the borrower passes away. The loan amount is based on the value of the home, the borrower's age, and the interest rate.
Key Questions to Ask Before Taking Out a Reverse Mortgage
1. What are the costs associated with a reverse mortgage?
Just like traditional mortgages or home equity lines of credit (HELOCs), reverse mortgages come with certain fees and charges. These costs can include appraisal fees, legal fees, and administrative fees.
Typically, the costs associated with a reverse mortgage are around $1500-2000, which can be paid from the loan proceeds rather than out-of-pocket. Appraisals are approximately $500 and legal fees are approximately $1200. Just like the lender’s fees, these other costs can also be paid from the loan proceeds, rather than out-of-pocket. Overall, we do think potential borrowers should view the upfront costs of a reverse mortgage as being a reason to not get one.
2. How much can I borrow with a reverse mortgage?
The loan amount for a reverse mortgage is based on the value of the home, the borrower's age, and the interest rate. The older the borrower, the more they can borrow.
In Canada, the maximum loan amount from the leading reverse mortgage lenders is 59% of the value of the home. Smaller, regional reverse mortgage lenders may lend more amounts. If you are looking for these higher loan amounts, you should speak to your reverse mortgage advisor.
3. How can I receive my funds with the loan?
Reverse mortgages offer several options for receiving funds, including lump sum payments, monthly payments, and a line of credit (or even some combination of all three!).
It's important to understand the pros and cons of each option and how they can impact the overall interest costs of the loan. Essentially, the less you take up-front, the slower your interest costs build up over time. In this fashion, you can recreate the benefits of a HELOC in that you only pay interest on the reverse mortgage funds you use. An experienced reverse mortgage specialist will be easily able to help you decide the best way to receive your mortgage funds.
4. What happens if I outlive the loan?
In Canada, you cannot outlive your reverse mortgage loan as it does not become due until you die or sell the home. If you take a reverse mortgage from the top lenders, and if the loan balance exceeds the value of the home, the homeowner or their heirs will not be liable for the difference.
Not all of the reverse mortgage lenders offer this guarantee so it would be wise to discuss these details with your reverse mortgage advisor.
5. How will a reverse mortgage affect my estate?
While it's possible that the loan will reduce the equity your estate will receive, it's unlikely to happen since the reverse mortgage loan is designed to grow at the same rate as your property. In other words, even though your reverse mortgage balance is growing over time, your home value (and therefore, your equity) should be growing faster.
In our experience, most people end up providing their estate with more equity than they had at the time they obtained their reverse mortgage. In most of the other instances, borrowers give their estate roughly the same amount of equity as when they took their reverse mortgage. According to our conversations with HomeEquity Bank, less than 1% of all reverse mortgages end up in an equity loss situation. In this rare event, your estate and heirs will not be responsible for paying the difference to the lender.
6. What are the tax implications of a reverse mortgage?
Reverse mortgages typically do not have any tax implications: you don't pay taxes when you receive a reverse mortgage, and you also do not pay income taxes when you pay off a reverse mortgage.
There can be some tax implications if you use the loan funds to invest in an income-generating investment. In these cases, you can write off the loan interest.
7. How will a reverse mortgage affect my government benefits?
A reverse mortgage will not can impact your eligibility for government benefits, such as the Canada Pension Plan (CPP) and Old Age Security (OAS).
In fact, if you supplement your income with a reverse mortgage and wait as long as possible to receive your government pensions, these programs will actually give you more more every month.
8. What are the alternatives to a reverse mortgage?
It’s important to consider the alternatives to a reverse mortgage and to see if any of them suit your needs better. These alternatives would be a traditional mortgage, a HELOC, downsizing, or renting.
Here is a quick summary of the pros and cons of each alternative:
- Traditional mortgages and HELOCs are cheaper but harder to qualify for if the borrower is on reduced pension income.
- Downsizing is very expensive and means a lot of upheaval late in your life; and
- Renting is very expensive and difficult for seniors to accept after a lifetime of living in their own home.
You should speak to an experienced reverse mortgage specialist who can explain all of these alternatives in more detail and who can show you how well the reverse mortgage option fares in comparison to these alternatives.
In this article, we've briefly explored 8 key questions that you should ask before taking out a reverse mortgage in Canada. By understanding how reverse mortgages work, their costs,, and their impact on your estate and your government benefits, you can make an informed decision about whether a reverse mortgage is right for you.
1. Can I still own my home with a reverse mortgage?
Yes, you can still own your home with a reverse mortgage. The loan is secured by the home, but you remain the owner and can continue to live in the home as long as you meet the loan requirements.
2. What happens if I want to sell my home with a reverse mortgage?
If you want to sell your home with a reverse mortgage, you can do so at any time. The loan will need to be paid off from the proceeds of the sale, and any remaining equity will go to you or your heirs.
3. Can I pay off a reverse mortgage early?
Yes, you can pay off a reverse mortgage early at any time. Just like a traditional mortgage, you may need to pay a prepayment penalty.
4. How does a reverse mortgage affect my credit score?
A reverse mortgage does not affect your credit score, as it is not a credit-based loan. This is entirely different than traditional mortgages or HELOCs, which are also income-based loans.
5. What happens if I move out of my home with a reverse mortgage?
If you move out of your home with a reverse mortgage, the loan will become due. You will need to pay off the loan from the proceeds of the sale or refinance the loan. In these circumstances, typically, you have 180 days to pay off the loan.