A reverse mortgage allows Canadian homeowners who are at least 55 years of age to borrow money against the equity they’ve built in their homes.
Increasing numbers of homeowners who find themselves “house rich but cash poor” are attracted to the idea of freeing up some of the money they’ve invested in a home, especially when the housing market is booming, and house values are rising. But a reverse mortgage is not for everyone, nor is the borrowing process as straightforward as it may appear.
Learn everything you can about the pros and cons of a reverse mortgage before you decide to apply. There are likely alternatives.
What is a Reverse Mortgage?
The typical reverse mortgage is a new loan that allows homeowners to access up to 55% of the current value of their primary residence.
A conventional mortgage requires you to make payments that build equity in your home, but a reverse mortgage lets you borrow from that home’s value.
Here is an example. If you’ve paid off the original $600,000 mortgage on your house and its value is now $900,000, you could take out a reverse mortgage for as much as $495,000 — 55 percent of $900,000.
The maximum you can borrow depends on:
- your age
- your home’s appraised value
- your lender
- your location
Borrowers are not required to make any payments on a reverse mortgage until the loan is due, but the longer you go without making payments, the more interest accrues. As a result, at the end of your loan term, you may have less equity in your home than the amount you started with.1
The loan is due and must be paid back in full when the borrower:
- moves out
- sells the home
- passes away
- fails to pay taxes or insurance
If your spouse or co-owner dies, you will continue to be a borrower. However, if you or your surviving co-owner move into a retirement residence or long-term care, you may have up to a year to repay the reverse mortgage.
How Does a Reverse Mortgage Work?
Here is what you need to know about how reverse mortgages work.
Eligibility for a reverse mortgage considers the age of all title holders, the condition of your house, the type of structure your house is – single-family dwelling, detached, attached, townhouse etc., and the home’s appraised value. In addition, the home must be your primary residence – one in which you live for at least six months a year.
The lender will want to be sure you and other applicants fully understand the legalities of a reverse mortgage and may require you to get legal advice.
All outstanding loans, including a mortgage and any home-equity secured lines of credit (HELOC), must be paid off before getting the reverse mortgage.
You can take the reverse mortgage as a lump sum (and use it to pay off those outstanding loans) or take some money up front and the rest over time.
You can use the remainder of the loan for anything you wish, such as to:
- cover healthcare expenses
- help with household bills
- pay for home repairs or improvements
- repay debts
Ask your lender what payment options they offer for a reverse mortgage. Also, ask whether there are any restrictions or fees.
How Long Does a Reverse Mortgage Last?
Typically, the contract for all reverse mortgages is five years. However, if the borrower chooses a shorter term, such as a one-year fixed rate, the rate will reset to Canada’s current rates at the end of that term. After the five-year contract is up, a borrower can choose a new rate or pay off the reverse mortgage in full without penalty.
How Do You Pay Back a Reverse Mortgage?
Although there is a penalty for making prepayments on a reverse mortgage, lenders allow once-a-month prepayments on the interest. Terms for paying down the principal vary between Canada’s two primary reverse mortgage lenders, but typically prepayments can be made every twelve months and only up to 10% of the loan.
After a five-year term, more than 10% prepayments are allowed, depending on the lender. After ten years with the lender, more than a 10% prepayment is permitted at any time.
Pros and Cons of a Reverse Mortgage
A reverse mortgage might be a solution for some senior homeowners but not for others. Consider the pros and cons – and also the alternatives before you decide.
Pros of a Reverse Mortgage
- You don’t have to make any regular loan payments.
- You can turn some of the value of your home into cash without having to sell it.
- CRA does not collect tax on the money you borrow.
- The loan does not affect your Old-Age Security (OAS) or Guaranteed Income Supplement (GIS) benefits.
- You continue to own your home.
- You can choose when and how you receive the money. For example, borrow a lump-sum amount or set up recurring monthly, quarterly, semi-annual, or annual advances.
You can use the money in many ways:
- Pay for home repairs or improvements.
- Help with regular bills.
- Cover healthcare expenses.
- Repay debts.
- Make a down payment on another home.
Cons of a Reverse Mortgage
- Reverse mortgages always have higher interest rates than conventional mortgages because the lender’s funding costs are higher. Borrowers are not required to make payments, and lenders wait an average of 7 – 12 years to see returns.
- The equity you hold in your home may go down as you accumulate interest on your loan.
- Your estate will have to repay the loan and interest within a set time when you die.
- The time needed to settle an estate may be longer than the time allowed to repay a reverse mortgage.
- There may be less money in your estate to leave to your children or other beneficiaries.
- Costs associated with a reverse mortgage may be higher than a regular mortgage or other credit products.
- A reverse mortgage may limit other financing options secured by your home. For example, you may not be able to take out a HELOC or similar products.
What are the disadvantages of a reverse mortgage in Canada?
Older Canadians concerned they will outlive their retirement savings increasingly resort to reverse mortgages for funds. However, there is no guarantee that you won’t also outlive the amount of your reverse mortgage.
Disadvantages of a reverse mortgage in Canada include the following:
- A reverse mortgage has a higher interest rate than a traditional mortgage.
- The more you borrow, the faster that high interest accumulates.
- There is also a home-appraisal fee, a setup fee, and a prepayment penalty if you pay your reverse mortgage before it is due.
- Appraisal fees average $300. Setup fees, including legal advice and title registration, average $2500. The appraisal fee is payable upfront and is not refundable if you choose not to follow through on the reverse mortgage application or if you are turned down. Legal and administrative fees can be paid using money from the loan.
- In Canada, HomEquity Bank (CHIP) and Equitable Bank are the only two lenders that offer reverse mortgages.
- The only way to get out of a reverse mortgage is to pay it off, sell your home, or pass away.
Best Alternatives to a Reverse Mortgage
Before you dive into arranging a reverse mortgage, consider that there are alternatives that might be a better fit for you. There are only two reverse mortgage lenders in Canada, and it is not in their best interest to provide seniors with alternatives to borrowing against home equity. Reverse mortgages are a lucrative market with a specific, elderly client base.
What are some options other than a reverse mortgage that can help with day-to-day cash shortfalls?
Arrange a home equity line of credit (HELOC)
A HELOC is a secured form of revolving credit. The lender uses your home as a guarantee that you’ll pay back the money you borrow. A HELOC allows you to borrow just what you need up to the loan’s value and to make payments on the interest only. So, you can borrow money, pay it back, and borrow it again, up to a maximum credit limit.
Refinance Your Existing Mortgage
What does it mean to refinance a mortgage?
Refinancing your mortgage means breaking your current mortgage and paying it out in full with a completely new mortgage. The new mortgage usually differs in some beneficial way. For example, it could be for significantly more money, a better mortgage rate, a new term length and amortization period, or a different type of mortgage.
When increasing the mortgage amount, you can unlock additional equity from your home if its value has appreciated since you first bought it. Assuming you have enough income to qualify, you can unlock up to 80% of your property’s value through a mortgage refinance.
Although there are other funding sources, including an unsecured line of credit or personal loan, a mortgage refinance is typically the cheapest because your family home backs the loan; it’s a tangible asset that supports a lower borrowing cost. However, if you default on your loan payments, the lender could sell your home to recover what you owe.
When would you need to refinance your mortgage?
Refinancing may be the answer if you want to change your existing mortgage to take advantage of lower rates or to obtain some cash from your equity.
If your contract allows, you can refinance your mortgage in the middle of the term unless you have a limited feature mortgage. These only let you refinance with your existing lender or, in extreme cases, may prevent you from refinancing.
Reasons for refinancing your mortgage:
- Consolidate debt – Consolidating debt makes sense for any consumer debt with a higher interest rate than your mortgage.
- To lower your mortgage payment – If meeting your mortgage payments is challenging, consider refinancing your mortgage to lower the monthly amount. You can do that by lengthening your amortization period.
- Refinance your mortgage for home renovations
- Refinance your mortgage to save on interest
You might consider refinancing if your mortgage rate exceeds the current posted rate. There could be a penalty, however, so determine if the cost of the penalty is worth any potential savings on interest.
Apply for a Home Equity Loan
A home equity loan is different from a HELOC. A home equity loan gives you a one-time lump sum payment of up to 80% of your home’s value. After that, repayments are on a fixed monthly rate that includes interest and principal.
If you invest cash from your home equity loan, the interest qualifies as a tax deduction under certain circumstances. CRA may allow deductions for interest payments when you use borrowed money to buy investments. As long as your investments generate income such as dividends or interest, or if you reasonably expect that they will generate revenue, you can deduct the interest on your loan from your total income. Capital gains are not income for the purposes of this deduction. The interest is not deductible if you borrow to invest only in shares that don’t pay dividends and rely on capital gains to make money.2
Use The Smith Manoeuvre
Robinson Smith’s best-selling book, Master Your Mortgage for Financial Freedom teaches you how to use The Smith Manoeuvre in Canada to make your mortgage tax-deductible and create wealth.
What Is The Smith Manoeuvre?
The Smith Manoeuvre is a creative, legal, financial strategy designed for Canadian homeowners to convert the non-deductible debt of a house mortgage to the deductible debt of an investment loan. This strategy simultaneously ensures the speedy elimination of a non-deductible mortgage while building a free-and-clear non-registered ‘personal pension portfolio’ and enjoying substantial tax refunds annually for many years.
In his book, Robinson Smith describes how the typical Canadian homeowner who implements The Smith Manoeuvre could realize a benefit of approximately $400,000 or more over the life of their 25-year mortgage.
Since the strategy’s development, Canadians have been using The Smith Manoeuvre to keep more of their money to reduce home ownership costs and improve their financial security.