As Canadian homeowners get older, many start to face financial challenges and begin to come across the challenge of living comfortably in their retirement years.
How are Canadian retirees facing these challenges and maintaining their financial independence in retirement?
One option that is gaining popularity with homeowners is to get a reverse mortgage.
Is this option right for you? Are you curious about reverse mortgages?
In this article we will explore what a reverse mortgage is, how it works in Canada, and the advantages and disadvantages of a reverse mortgage.
What is a Reverse Mortgage?
A reverse mortgage is a type of loan that allows Canadian seniors to access the equity in their homes without having to sell or move out.
This home equity loan helps older homeowners improve their monthly cash flow and helps stay financially independent in their retirement years.
A reverse mortgage does not a homeowner to make make monthly payments and the loan does not have to be repaid until the homeowner sells the home, moves out or passes away.
A reverse mortgage still charges interest on the money borrowed but the interest is added back to the original loan amount rather than being paid off every month.
Over time, this adding back of the interest causes the reverse mortgage balance to increase, rather than decrease. Hence, the product is called a “reverse” mortgage.
Let’s look more closely at reverse mortgage advantages and reverse mortgage disadvantages.
11 Reverse Mortgage Pros
- No Monthly Payments
One of the biggest advantages of a reverse mortgage is that the borrower does not have to make monthly mortgage payments.
Since a retiree will not have this monthly payment, they will have more money every month to pay for their other living expenses. Their monthly cash flow will improve and they will have more financial flexibility.
- No Income Requirements
Most retirees will struggle to qualify for a traditional loan or a regular home equity line of credit because they are on pension income.
Even if they are mortgage-free, a lender will require them to have enough monthly income to make the payments on these traditional loan products.
A retiree won’t struggle to qualify for a reverse mortgage loan because a reverse mortgage lender will not require a minimum amount of income in order to service the loan (again, because no monthly payments are going to be made).
- No Credit Requirements
Retirees who have bad credit will struggle to qualify for a traditional home equity loan or a home equity line of credit because lenders will require a borrower to have a minimum credit score in order to qualify for a loan.
Reverse mortgage lenders do not focus on the credit score of a retiree since payments are not required. As a result, seniors who have bad credit can still qualify for a reverse mortgage.
- Different Ways to Receive Money
Retirees don’t always require a large amount of money up front. In some cases, they only need a small amount every month to supplement their pension income.
Reverse mortgages are very flexible in these situations and can be set up to provide the retiree with the money in a lump sum (similar to a home equity loan) or as a series of regular payments (similar to a home equity line of credit).
- Money Received Tax-Free
The money received from a reverse mortgage is not considered income. As a result, it will not be taxed by the government when it is received nor will it be included in the retiree’s income taxes.
- Doesn’t Reduce Government Benefits
Since the money received from a reverse mortgage is not considered income, it will also not affect other government benefits, such as Old Age Security (OAS) or Guaranteed Income Supplement (GIS).
- Preserve Other investments
If a retiree has investments that are earning interest or increasing in value (such as RRSP’s, TFSAs, stocks, mutual funds, etc.), they can avoid selling these investments by getting a reverse mortgage.
- No Restrictions On Money Use
When a homeowner gets a reverse mortgage, there are no restrictions on how they use the funds.
Borrowers can use the money from a reverse mortgage to pay for home renovations, travel, helping family or any other expenses they may have.
- Stay in Your Home
Seniors overwhelmingly want to stay in their homes as they get older.
With a reverse mortgage, seniors can live in their home for life and stay close to the friends and support network that they have spent years building up.
- Avoid Downsizing Costs or Renting
If a senior is considering downsizing for financial reasons, they often forget to consider the significant costs of downsizing, such as real estate commissions, legal fees, and moving expenses.
These fees will typically be 5% to 6% of the value of their home!
Typically, a homeowner only needs an extra few thousand dollars every month in order to stay in their home. If they can get this additional money from their home equity using a reverse mortgage, we think it’s a good choice for retirees in these circumstances.
This reverse mortgage solution also allows a homeowner to avoid the stress of downsizing and finding new living arrangements.
- Delay Taking CPP or OAS
By accessing the equity in their home through a reverse mortgage, seniors can delay taking their Canada Pension Plan (CPP) or Old Age Security (OAS) benefits, which can result in higher monthly payments in the future.
7 Cons of a Reverse Mortgage
Reverse mortgages aren’t perfect for everyone and there are some things a homeowner should be aware of before they get a reverse mortgage.
- Higher Interest Rates than HELOCs/Mortgages
The interest rates on a reverse mortgage are typically higher than those on a home equity line of credit or traditional mortgage.
Are they extremely high interest rates? We don’t think so, especially considering a borrower is not making monthly payments, may have bad credit and will likely not repay the loan for a number of years.
Here is a comparison of how CHIP reverse mortgage interest rates compare to other loan products:
Reverse mortgages are issued by HomeEquity Bank and Equitable Bank, both federally licensed banks, that must comply with regulatory requirements for mortgages, interest rates, costs of borrowing and disclosure.
In other words, reverse mortgages are well-regulated and homeowners should not feel concerned they are going to be charged “criminal” interest rates.
- Reduced Equity Risk
As the balance of the reverse mortgage increases, people claim the amount owing will reduce their equity and eventually, a person will owe more than the home is worth.
Based on industry data, and our experience, this is simply not true.
Even though the reverse mortgage balance is growing over time, so is the value of the home. In our experience, the value of the home increases faster than the balance of the reverse mortgage.
Simply put, we find most people who get a reverse mortgage have more equity than they did when they first got a reverse mortgage.
It is possible that property values could fall, but we find that reverse mortgage lenders to be quite cautious when lending money and they maintain a healthy cushion of home equity to deal with any unexpected property value drops.
- Higher Setup Fees
Seniors are not used to paying a setup fee when they get a traditional mortgage or home equity line of credit.
Reverse mortgages in Canada require homeowners to pay a one-time setup fee to the lender, the amount can range from $995 to $1995 and this amount can be paid from the loan proceeds.
If a reverse mortgage is otherwise suitable for you, we would never recommend you avoid getting one simply because of this one-time expense.
- Higher Prepayment Penalties
Reverse mortgages charge the borrower a prepayment penalty if the loan is paid off before the homeowner sells the home.
Notice we didn’t say “if the reverse mortgage is paid before the term expires”?
That is because a reverse mortgage prepayment penalty is based on the loan’s anniversary date, not the term and you can pay a penalty even though the term has expired.
For example, if you get a reverse mortgage on January 1, 2022 for a 1 year term and wish to pay it off on January 1, 2023, you will still pay a prepayment penalty because the loan is being paid off on its first anniversary.
The prepayment penalty decreases the longer you have a reverse mortgage. If you have a reverse mortgage for 10 years or more, then you do not pay a prepayment penalty.
- Minimum Age Requirements
Traditional mortgages and home equity lines of credit do not have age requirements. Reverse mortgages are only available to homeowners over the age of 55. There is no upper age limit with reverse mortgages.
If you are a homeowner looking to get a reverse mortgage, this means you may have to wait until all homeowners are at least 55.
- Restricts Home Ownership
Many homeowners wish to put their children on title as part of their estate planning so the children can inherit the home when the parents pass away.
Reverse mortgages can prevent parents from putting their children on title if they are under the age of 55.
Even if the children are older than 55 years old, their lower age will reduce the parents ability to qualify for a large reverse mortgage amount.
Affects Other Financing Options
With traditional mortgages, homeowners are often able to obtain secondary financing (commonly by getting a home equity line of credit).
Unfortunately, most traditional lenders will not allow their loan to be placed behind a reverse mortgage (because of the increasing loan balance).
This means that once you get a reverse mortgage, your ability to get secondary financing will be limited.
- Minimum Home Value Required
Unlike traditional mortgages or home equity lines of credit, reverse mortgage lenders require the property to be worth at least $100,000.
Is a Reverse Mortgage Right for You?
Whether a reverse mortgage is right for you depends on your specific financial situation and goals. Here are some questions to ask yourself to determine if a reverse mortgage is right for you:
1. Do you own a home with a minimum value of $100,000?
2. Are you at least 55 years old?
3. Do you need to access the equity in your home to improve your monthly cash flow or pay for expenses?
4. Do you want to preserve other investments, such as RRSPs or TFSAs, for future use?
5. Are you comfortable with the costs and risks associated with a reverse mortgage?
If you answered yes to these questions, a reverse mortgage may be a good option for you.
Wondering how much you could get from a reverse mortgage? Try our reverse mortgage calculator to get a quick estimate and then reach out to us to learn more about the process.
A reverse mortgage can be a valuable financial product for Canadian seniors who want to access the equity in their home without having to sell or move out.
While there are a number of advantages of getting a reverse mortgage, there are a few disadvantages that you should consider before you make any decisions.
We recommend you contact one of our experts at RetireBetter to help you navigate the process.
By considering the pros and cons of reverse mortgages and asking the right questions, you can determine if a reverse mortgage is right for you and take the first step towards a more comfortable and independent retirement.
Q: What happens if I outlive the loan?
You cannot outlive a reverse mortgage loan in Canada.
Your reverse mortgage will continue for your entire life, so long as you live in and own the home, maintain the property and keep your property taxes current.
Q: Can I get a loan and still leave my home to my heirs?
Yes, you can still leave your home to your heirs.
However, the amount of equity in the home may be reduced by the amount of the reverse mortgage loan if the property value drops significantly over time.
Q: What happens if the value of my home decreases?
If the value of your home decreases, the amount of equity may also decrease.
However, the borrower is not responsible for any shortfall if the loan balance exceeds the value of the home at the time of repayment.