Q: I’ve heard I should avoid a reverse mortgage at all costs. Is that true?
A: A reverse mortgage is a type of loan that allows homeowners 55 and older to borrow money from their home’s equity (the difference between what you still owe on your mortgage and the current market value of your home) without selling the home. This is done by converting a portion of your home equity into tax-free money — the money is a loan, not income, so it doesn’t affect government benefits like Old Age Security (OAS) or the Guaranteed Income Supplement.
The loan balance, including any interest accrued, becomes due when the homeowner sells the home, moves out permanently or dies. You can qualify for a reverse mortgage even if you’re still paying off your mortgage, but the money you borrow from the reverse mortgage must be used to pay off your existing mortgage. So if you owed $50,000 on your mortgage and you get approved for a reverse mortgage of $100,000, the first $50,000 must go toward paying off your mortgage; the rest is paid out to you.
For most Canadian homeowners, a reverse mortgage is not the best use of the equity in their home, says Matthew Ardrey, portfolio manager and senior financial planner at TriDelta Private Wealth.
One of the biggest issues with reverse mortgages is the high interest rate that compounds over time. For example, Ardrey says, if a homeowner has a $600,000 home and takes out a $150,000 reverse mortgage at a rate of 6.59 per cent, the debt against the home would be $206,383 after five years; after 25 years, it would be $610,736.
As the amount of interest on the loan compounds over time, increasing the outstanding amount owed, the equity in the home is eroded.
“It is a scary thought that by only borrowing 25 per cent of the home’s value, it could cause debt larger than the current value of the home,” Ardrey says. You also have to consider the impact of future interest rates. “If interest rates move higher during the term of the mortgage, the outstanding debt would increase at a much more rapid pace,” Ardrey explains.
A lender will consider the value of your house and your age when determining how much you can borrow. You can receive the money from a reverse mortgage as a lump sum for the entire amount, regular payments (typically monthly or every three months) or a lump sum for a portion of it and the rest over time.
So who would a reverse mortgage work for? It may be the only option for some homeowners who are “house rich and cash poor” and need additional income to cover day-to-day living expenses, Ardrey says, adding that it’s often more difficult to get traditional loans or credit when someone doesn’t have much income.
Ardrey highly recommends seeking the advice of an accredited financial planner before deciding to apply for a reverse mortgage to see what options are available to them. “A reverse mortgage is never the only option,” he says. “If the homeowner downsizes or sells their home instead, they retain more value over time and will likely be able to enjoy a higher standard of living than if using the reverse mortgage.”
Money Coach is a weekly feature that helps Canadians find helpful solutions to personal finance challenges. If you have a question, email Lora at [email protected].
