The pros and cons of a reverse mortgage to help pay off your debts
By Sandra Fry
Are you running out of retirement savings? Do you have a lot of debt, but your monthly income is too low to afford the payments? Or maybe you own your own home and want to access the equity. If you’re 55 or older, a reverse mortgage might seem like an attractive option.
As with every financial choice, however, it’s important to carefully weigh the pros and cons of a reverse mortgage before entering into an agreement against your future home equity.
A reverse mortgage is a loan that allows you to access the equity in your principal residence without having to sell it and without having to make payments until you move out, sell the home or the last borrower passes away. There are two lenders in Canada who provide reverse mortgages: HomeEquity Bank offers the Canadian Home Income Plan (CHIP) while Equitable Bank offers reverse mortgages in a limited number of cities.
Once granted, a reverse mortgage can provide a one-time lump sum of money, ongoing smaller amounts to top up monthly income from other sources, or a combination of both. It could be a good way for senior homeowners to age in place if they don’t have the income to support traditional mortgage or home equity line-of-credit payments.
The income derived from accessing your home’s equity is not taxable, so it will not impact your Old Age Security (OAS), Guaranteed Income Supplement (GIS) or any other income-tested benefit. You may also use the money for anything you desire, such as a trip, renovations, payments on non-mortgage debt (for example, credit cards or car loans) or medical expenses.
If all this sounds too good to be true, it might be.
There are lending criteria that might make a reverse mortgage less accessible than a traditional one. Along with the 55-plus age requirement for all borrowers, everyone on title of the property must be listed on the application. The reverse mortgage can only be for a maximum of 55 per cent of your home’s current value and any loans, lines of credit or mortgages that are secured by your home must be paid off before the reverse mortgage is granted. Depending on your loan agreement, the lender may allow you to pay those secured debts off with the proceeds of the reverse mortgage. You must also keep up to date with maintenance, insurance and property tax payments.
Interest rates are typically higher than those on a conventional mortgage because the lender is gambling on the future value of your home. In terms of upfront costs, you will need to pay for an appraisal, as well as application and legal fees. A lender may insist you obtain independent legal advice before it grants the loan. And a prepayment penalty typically applies if you pay the mortgage off within the first three to five years.
The biggest risk with a reverse mortgage is that the interest compounds and chips away at your equity. If you’re counting on using that equity to pay for medical costs or living in a senior’s care facility one day, passing it on to your heirs or leaving a financial legacy in your community, there might be much less money left over than you need depending on market conditions at the time your home is sold.
Holding onto your home and renting it out is also not possible once it has a reverse mortgage registered against it. And after the final owner passes away, the estate could have to pay the reverse mortgage off before the estate is settled.
If you or an older friend or relative is struggling and considering a reverse mortgage, it’s important to consider all your options before making a commitment. Look into whether a conventional mortgage or home equity line of credit is feasible. If the goal is to generate income with the home, meet with a tax professional to understand what that means for your overall financial picture.
If maintaining the home has become unaffordable or unmanageable, selling it and downsizing might be an option. I often point out to seniors who believe they can’t afford to live elsewhere that renting can be a cost-effective option because their mortgage is paid off. The money they get from selling their home can be invested and/or used to fund living expenses elsewhere. There are tax implications with investment income, so seek sound advice before choosing this option.
How to save at the grocery store as food inflation continues to soar
Household makeover: a financial success story to show how you can live within your means
Due to the potential drawbacks of a reverse mortgage, it’s worth discussing all options with your loved ones and appropriate professionals while you’re in good health and of sound mind. A non-profit credit counsellor can help point you in the right direction if you’re not sure where to start.
Be cautious before entering into an agreement to chip away at your home equity. Your loved ones may even be able to help you safeguard your equity while they share the costs, taking over ownership at a time that’s beneficial for them. Your home might then truly be lending a hand.
Sandra Fry is a Winnipeg-based credit counsellor at Credit Counselling Society, a non-profit organization that has helped Canadians manage debt for more than 26 years.
If you like this story, sign up for the FP Investor Newsletter.