Financial Friday 178: Can a Reverse Mortgage Save Your Retirement Plans?
Home prices continue to rise in Canada and many seniors are wondering how they might convert some of that equity into cash to fund their retirement.
The simple solution is to sell and downsize. Get rid of all that old junk you no longer need and move to a smaller, less expensive home and pocket the difference. Another option would be to stay in your home and rent out the basement, maybe put a student in a spare room, or even try some short-term rentals like Air B&B — if there is demand and it is allowed in your location.
There is another option which has become increasingly popular, a reverse mortgage. The total outstanding reverse mortgage debt has been growing at 10% or more for the last few years and has now reached $6.7 billion in Canada. What is a reverse mortgage and does getting one make sense?
A reverse mortgage allows you to borrow money based on the value of your home, with the home itself being used to secure the loan. Your age and the market value of your home are the two major factors affecting how much you can borrow, but the maximum is 55% of the home value.
You can receive the money as a lump-sum or get a regular payment each month to tide you over. There are no fixed repayment terms or taxes, but there are plenty of setup fees (appraisal, closing & admin fees). Annual interest rates run about 3% higher than a conventional mortgage, so you are currently looking at an eye-popping interest rate of somewhere between 7.5% and 9.9%.
Other considerations: you must first settle any other liabilities secured by the home, the home must be your principal residence, and if you move, sell or die, the reverse mortgage needs to be settled.
If you are thinking this doesn’t look like a very attractive option from a purely financial perspective, you are probably correct. A home equity line of credit (HELOC) would be a much cheaper loan alternative if you can get one, and selling the home outright would likely make more financial sense.
Taking $2500 monthly on a reverse mortgage at 8% for ten tears would cost you over $160,000 in interest and erode your home equity by over $460,000. If you borrowed the same amount ($300,000) but elected to received the money up-front in a lump-sum payment, it would lead to interest accumulation of over $365,000 ten years down the road and wipe out $665,000 of your equity. It's important to keep in mind that interest rates (there are fixed and variable rate reverse mortgage options) and home values go up and down, so the cost/benefit can vary greatly.
While the numbers can be shocking at current interest rates, a reverse mortgage is relatively easy to obtain if you really want to stay in your home. There are situations where a reverse mortgage makes sense. For example, if your elderly parents fell ill and homecare is available, they might be more comfortable staying in their own home. There may also be areas where suitable live-in care facilities are unavailable and staying in their home is the only option. Another situation would be to retain ownership by your estate. Your survivors would have the option to settle the reverse mortgage at the time of your death and keep the home in the family.
Reverse mortgages are basically a loan of last resort. If you are pushing 80 and living on a fixed income, it's one option if you need cash for medical expenses, house repairs, or some other necessity. If you are planning on retiring at 65 and using one to finance your retirement life… think again!
Like all financial decisions, make sure to educate yourself so you can analyze the implications and explore all your options before signing on the dotted line. If you are thinking about your retirement plans, our one-on-one financial coaching program offers completely unbiased, professional financial education and guidance. We can help you evaluate your situation, explore your options, and work with you to build a customized action plan based on your needs. Why not book a free financial assessment call to learn more about our coaching program and see if it is a good fit for you?
Resources:
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