Financial Friday #83: Reverse Mortgages on the Rise
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. You could also try to secure a home equity loan or line of credit (HELOC), although there may be some limitations if you are retired.
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 $4.2 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. There are lots of factors affecting how much you can borrow, with the maximum at 55% of the home value. The are no fixed repayment terms and it is tax-free, but interest rates run about 3% higher than a conventional mortgage, so you are looking at around 5%. Just like a regular mortgage, there are fixed and variable rate options.
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 good option for you, you are probably right. A HELOC would be a much better loan alternative if you qualify, and selling the home may make more financial sense. On the other hand, a reverse mortgage is relatively easy to obtain if you really want to stay in the home.
If home prices continue to rise and interest rates remain low, you could actually still grow your net worth (albeit at a slower pace) even with a reverse mortgage. Last year we saw 20%+ price increases on homes with a reverse mortgage running at 5% — that might be one reason why their popularity is on the rise!
There are some other situations where a reverse mortgage makes sense. For example, if your elderly parents fell ill and you could arrange homecare, they might be more comfortable in their own home, or maybe there aren't any suitable live-in care facilities available. 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, and need cash for medical expenses, house repairs or some other necessity, it’s one option. If you are planning on retiring at 55 and using one to finance the next 30 years of retirement; think again!
Like all financial decisions, make sure to educate yourself so you can analyze all the implications and explore all your options before signing on the dotted line.
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