According to recent statistics, Canadians are concerned that their savings will run out within 10 years of their retirement. For many Canadians, they are looking for every opportunity to increase their savings, or to eliminate unsecured debt. One of the options might be a reverse mortgage.
What Is a Reverse Mortgage?
A reverse mortgage is a way to convert your home equity into a series of monthly payments to you. In a traditional mortgage, you borrow a lump sum against the equity in your home and pay it back over time with interest. In a reverse mortgage, you pledge the equity in your home in exchange for a monthly payment to you. The payment amount plus associated interest accumulates and is paid back only when you pass away or sell your home.
Retire Happy defines a reverse mortgage as follows:
“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.”
How Do You Qualify for a Reverse Mortgage?
Reverse mortgages in Canada have several requirements to qualify. For example, you must be at least 55 years of age, own your home and have sufficient equity. Generally, the older you are when you sign up for a reverse mortgage, the more equity you can borrow, this because (from the lender’s point of view) the older you are, the less time you’ll have to spend it.
What Are the Disadvantages of Reverse Mortgages?
The pros associated with reverse mortgages are obvious. For example, you’ll eliminate your monthly mortgage payment, the payments you receive will be tax-free, and you don’t need to repay the loan until you either sell your home or pass away. The disadvantages are sometimes not quite so clear, but you need to know what they are before you take this important step. Following are 6 potential disadvantages of taking out a reverse mortgage in Canada:
- Interest rapidly accumulates: although it’s true that your home might increase in value over the life of your reverse mortgage, and that this appreciating value can offset some of your interest costs and loss of equity, it’s also true that interest will quickly accumulate on the amount you borrow.
- Reverse mortgages can be risky: you can of course invest the money you save on monthly mortgage payments, but, unlike home equity, those investments add an element of risk to your financial portfolio.
- Reverse mortgages are more costly than conventional lines of credit: when you take out a reverse mortgage loan, you’re looking at start-up fees and higher rates of interest. Those start-up fees and interest rates can be substantial. For example, the start-up fees you end up paying depend on what options you choose. They typically include an application fee, a home appraisal fee and the costs associated with getting independent legal advice. Costs can run as high as $2,500.
- There are prepayment penalties: in order to maintain the reverse mortgage, you must continue to reside in the home. Should you become ill or need to move in with a family member or perhaps to an assisted care facility, the loan will become due and must be repaid. If you decide to pay off some or all of you reverse mortgage loan, you could face substantial prepayment penalties. In addition, when you borrow against the value of your home, you decrease the amount of money you can pass on to your beneficiaries.
- Your borrowing options are limited: in Canada, only two companies offer reverse mortgages. These are the Canadian Home Income Plan (CHIP) and Seniors Money Canada. This means you don’t have the same leverage or ability to “shop around” as you would with other types of loans.
- The amount you can borrow varies greatly: how much you are actually able to borrow can vary greatly depending on a number of factors, such as your geographical location, what type of house you own, your gender and your age. In some cases, the combination of these factors can substantially limit the amount you’re able to borrow.
Choosing a reverse mortgage can reduce your monthly bills and provide you with additional income you wouldn’t otherwise have, but it can also come with some definite disadvantages. Above all, you need to get the facts, so you can make an informed decision. Before you sign on the dotted line, you should consult with a competent financial advisor. As with other important financial decisions you make, it’s always better to be safe than sorry.
Photo by Nick Hillier on Unsplash