The Reverse Mortgage: Pros and Cons for Retirement Income
“Why not both?” This is the answer the wife gives to her husband when he asks whether they should install an indoor or an outdoor hot tub. Perhaps you recall that commercial from one of the major providers of reverse mortgages in Canada. While the frugal person in me is inclined to believe I will never need a reverse mortgage, there may yet be circumstances when this source of money may make the most sense for retirees.
Circumstances that may have you considering a reverse mortgage
With rising home prices in many parts of the country, Canadians are finding that a home makes up an increasing proportion of their household net worth. Indeed, some may not have been able to save for their retirement after taking care of their mortgage and other payments throughout most of their lives. Many may be wealthy on paper, with $1 million-plus homes, but find that all their net worth is tied up in the real estate that they worked so hard to pay off.
After a lifetime of working, retirement approaches, and the near-retirees realize that they don’t have enough saved up to supplement their Canada Pension Plan (CPP), Old Age Security (OAS), and possibly Guaranteed Income Supplement (GIS). At least, the savings won’t be enough to allow them to live their hoped-for retirement lifestyle. Some may choose to sell their home and rent, or purchase a less expensive property in a more affordable community. However, there may be some issues that make moving an intolerable option. For example, if you were in this position and there were children and grandchildren nearby, how willing would you be to move farther away? Another reason downsizing and/or moving away may be untenable is so that you can accommodate guests – like grandchildren – for overnight stays. Of course, not everyone is in that position, but many are.
What is a reverse mortgage?
At its most basic, a reverse mortgage is a loan from a financial institution that allows you to get money from your home equity without having to sell your home. Typically, you may borrow up to 55% of the current value of your home. Fifty-five comes up another time, too, in that you must be at least 55 years old to qualify. If there are two people on the title, a married couple, for example, then each must be at least 55 years old.
Other factors in determining how much you can borrow are your age, your home’s condition and appraised value, and your lender’s policies.
What are the pros of a reverse mortgage?
Some might suggest that a Home Equity Line of Credit (HELOC) is preferable to a reverse mortgage as the interest rates tend to be lower. However, you may find it difficult to qualify for a HELOC if you do not have adequate income. Furthermore, you will need to make regular interest payments. Even more significant, your HELOC lender may decide to call the loan and demand you pay back all that you’ve borrowed, forcing you to sell your home.
In the case of a reverse mortgage, however, you don’t need to make regular loan payments, you do not pay tax on the money you borrow, you still own your home, and you typically have options regarding how you receive the money. On the latter point, you can borrow a lump sum for a significant expense such as to repair or renovate your home or pay off higher-interest debt. Alternatively, you can borrow smaller amounts periodically as you need the funds.
Concerning tax, let’s suppose you have some savings in an RRSP. As soon as the money is withdrawn from your plan, you will find your financial institution withholding a certain percentage of the withdrawn amount to remit to the CRA on your behalf. When you file your tax return the following spring, you will have an income tax slip known as a T4RSP to contend with. If you have already converted your RRSP into a RRIF, then you will be taking mandatory payments and therefore paying tax based on your amounts withdrawn each year. While limiting your withdrawals from the RRIF to the Annual Minimum Payment (AMP) does not trigger withholding, you will still need to pay tax based on your T4RIF, and if you withdraw larger amounts, you will pay more tax and have a portion withheld at the time of the withdrawal(s).
Even worse, if you are over 65 and receiving OAS and GIS, the extra income may reduce or eliminate the amount you are eligible to receive from these programs.
None of these tax-related situations apply if you borrow money against the equity of your home.
Lastly, even if the balance owing exceeds the value of your home, you will not owe more than your house is worth. It is effectively a kind of insurance policy.
What are the cons of a reverse mortgage?
While you don’t need to make interest payments with a reverse mortgage, that does not mean you are not being charged interest. Instead, the interest is accumulating and being added to the amount that you borrowed. This may not be a terrible thing if the market value of your home keeps on going up at a rapid pace, but continuing increases are by no means guaranteed.
Furthermore, the interest rates for reverse mortgages are typically much higher. HomeEquity Bank is the provider of the CHIP Reverse Mortgage, probably the most well-known of providers. On their website, they provide the following rates as of January 24, 2022:
For comparison purposes, I went to lowestrates.ca to get quotes from several providers. Five-year fixed rate mortgages came in as low as 2.64% and as high as 4.79%, with the average at 3.60%.
If your death is the event that triggers the repayment of the mortgage and the accumulated interest, your estate will be responsible to make the payment and it will need to be made on time, according to the terms of the mortgage. If your estate takes longer to settle than the time allotted in the mortgage contract, this can be problematic.
Of course, this may be of little concern to you if you do not have any heirs, but an obvious outcome of using a reverse mortgage is that you will have a smaller estate to leave to your heirs than you would if you did not rely on this source of income. On the other hand, if you need a certain amount of additional income to live even a modest life, leaving an estate may weigh less among your concerns.
Other than death, selling or moving out of your home is another trigger that will wind up the mortgage and require repayment. As authors Alexandra Macqueen and David Field observe in the 5th edition of The Boomers Retire, if you find yourself needing to move into a nursing or retirement home and were counting on the capital from the sale of your home to fund the out-of-pocket expense of this form of supported living, you may have insufficient equity to pay for that purpose.
A reverse mortgage is not an unmitigated good, but it can be a useful tool for seniors in particular circumstances, as financial consultant Judy Sennett asserted in the case of her parents. If this is an option you are considering, review the pros and cons above plus any others that may apply to you personally, and speak with a disinterested and competent third party before deciding.
This is the 132nd blog post for Russ Writes, first published on 2022-01-24.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.