A Primer on Reverse Mortgages
You’ve probably heard of reverse mortgages before and probably already have a negative opinion on them. You may have good justification for not liking them as they are fairly high interest mortgages that are targeted to seniors with low cash flow. However, lets get into details a bit and see what they are really all about.
What is a Reverse Mortgage?
A reverse mortgage is basically refinancing a home (for seniors) in order to get the equity out today with no monthly payments until the full loan is due when the homeowner passes away or moves. It provides tax free money to the senior homeowner in exchange for a hefty interest rate loan that compounds semi-annually over time. The bright side is that the home owner will not need to make payments until the loan is due in full. The problem is that by the time the loan is due when the home owner passes away or moves, there is typically very little equity remaining in the home. This means nothing will be left behind to the next generation.
There are very few reverse mortgage providers in Canada with the largest being Canada Home Income Plan (CHIP). CHIP will reverse mortgage up to 40% of the value of the home for homeowners age 60 and over. Of course, the older the homeowner and the more the equity that is in the home, the closer to the 40% loan to value (LTV) they will receive. They provide a variety of payment options from monthly equity payments to lump sums
As you can imagine, the interest rate charged on reverse mortgages are higher than regular mortgages. In addition to that, since no payments are made, they interest due grows very quickly (compounded semi-annually). As of today, CHIP charges up to 8.95% on their reverse mortgages. That means if CHIP lends you $100,000 today, in 10 short years, there will be over $240,000 owing on the home.
- As mentioned above, it allows seniors with very low cash flow to draw on the equity in their homes to fund their lifestyle. If the senior is not concerned with leaving an inheritance to the next generation, then a reverse mortgage may be a viable solution.
- The reverse mortgage payments are tax free and does not affect income tested benefits (GIS and OAS).
- The total owed will never exceed the value of the home.
- With the high interest rates, the equity in the home will disappear quickly as shown above.
- If the homeowner keeps the reverse mortgage for a number of years until he/she passes, there will be very little left for the next generation.
Getting a reverse mortgage is an expensive choice, but it can be a viable solution depending on the situation. In my opinion though, a reverse mortgage should be the last resort after considering other options like selling and downsizing or renting out a portion of your home.