I've heard from more and more clients who are starting to ask questions about reverse mortgages. There was a time that I was very skeptical about them, however, they do provide a solution for the right clients. One question I hear all the time is, how does a reverse mortgage work?
A reverse mortgage is available to homeowners aged 55 and older. You retain home-ownership and can access equity up to 55% of the value of your home. A reverse mortgage does not require monthly payments, however, the interest is accrued over time. You are required to keep property tax, house insurance, and condo fee payments up to date.
As I had mentioned before, I was skeptical. I didn't have all the facts and I thought that other mortgages provided better options. I have to admit, there are situations where a reverse mortgage is an excellent solution.
There are two main lenders in Canada who offer reverse mortgages. Let's review and clarify how reverse mortgages work. I will also provide a couple of client examples where the reverse mortgage helped.
What if I don't need all the money I've been approved for upfront?
In Canada, a reverse mortgage can be set up one of two ways. You can receive the funds as a lump sum, or you can receive the funds over time.
When you receive a lump sum, the amount is equal to the total amount you have been approved for. For example, if you are approved for a reverse mortgage of $200,000, then you can take all that money as one lump sum.
If you don't want all that money, or if you want to draw the amount over time, then you can choose the second option. You can choose an advance-able reverse mortgage. The lenders will require a minimum initial lump sum of at least $20,000 then you can draw out additional funds either monthly, quarterly, or infrequently. You can basically draw funds as you need them or schedule regular withdrawals.
This second option gives you a little more flexibility and you only pay interest on the funds that are drawn and used by you. This can reduce your interest costs over time.
Both options offer fixed rates and variable rates. If you choose to take advances over time, you may have to choose a variable mortgage rate instead of a fixed. It depends on the lender and some other factors.
If you have any outstanding debt that is registered against your home. That is, if you have a first mortgage or existing home equity line of credit, then you will have to pay that amount in full when the reverse mortgage is set up.
Any money left over after paying off your first mortgage, or home equity line of credit will be available for you to draw and use as you see fit.
How Do I Qualify For A Reverse Mortgage?
The main qualifying criteria for a reverse mortgage is your home's value and your age. Lenders do not consider your income. Lenders do not consider your credit rating. Most of the qualifying criteria are based on the value of your home.
To initially determine how much of a reverse mortgage you qualify for, we would need to review the following details:
- your age
- the location of your home
- type of home (detached, townhouse, duplex, condo, etc.)
- home value
- the condition of your home
Even if you have bruised credit, you can qualify for a reverse mortgage. The lenders offering reverse mortgages are only offering to provide financing to a maximum of 55% of the value of your home. Lenders do not expect you to make any payments back to them until the home is sold. Therefore, your credit isn't a big factor in the qualifications.
Because you aren't expected to make payments, your income isn't used to calculate how much you qualify for either. You do have to keep your property taxes, house insurance, and condo fees (if applicable) paid up to date. The lender will verify this on a regular basis. Therefore, you will have some costs to maintain your home.
In most provinces, as a senior you can apply for property tax deferral or property tax relief. If you have a reverse mortgage, the lenders will allow you to apply for and set up a property tax deferral/relief program where you live.
Here are a list of resources based on the province you might live it, if you want to apply for property tax relief/deferral:
- Alberta Senior Property Tax Deferral: Source
- British Columbia Home Owner Grant: Source
- Manitoba Property Tax Deferral: Source
- New Brunswick Property Tax Deferral: Source
- Newfoundland property tax rebates are set up individually by each municipality
- North West Territories Property Tax Relief: Source
- Nova Scotia Property Tax Rebate: Source
- Nunavut property tax relief: Source
- Ontario Property Tax Grant: Source
- Prince Edward Island Property Tax Deferral: Source
- Quebec Property Tax Grant: Source
- Saskatchewan Property Tax Deferral: Source
- Yukon Property Tax Deferral: Source
If you have a property tax deferral in place already when you apply for the reverse mortgage, that deferred debt will have to be paid in full. However, once the reverse mortgage is set up, you will be able to apply for the program again.
You will not be required to pay off the new property tax deferral program unless you set up a new reverse mortgage or sell your home.
I Don't Make Payments? How Does That Work?
With a reverse mortgage, you are not expected to make weekly payments or monthly payments, so where do they go? The interest that is charged on the reverse mortgage is added to the principle of the mortgage. The mortgage balance will raise over time as interest continues to be added to the principle of the reverse mortgage.
Over time you will start to pay interest on the interest and the amount of money you owe to the lender will increase over time.
If you don't need to access all the money at once, you could potentially set up a reverse mortgage where you can draw out funds as you need them. This way you will not be paying interest on money that you aren't using. You will only pay interest on the money you have drawn.
This type of reverse mortgage will also allow you to pay some money back. Not everyone will do this, but it's possible. If you sell something that you own and don't need the money right away, you could pay down your reverse mortgage. Then draw the money back out later when you do need it. This can save some interest costs for you and offers some flexibility.
Let's compare a reverse mortgage and a home equity line of credit.
Let's assume a client is 70 years old, owns a home worth $500,000. She has pension income, good credit. She qualifies for a reverse mortgage of $185,000. She would also qualify for a Home Equity Line of Credit for $185,000.
This client could take the reverse mortgage as a lump sum, that is all $185,000 or she could draw a monthly payment to supplement her income. If she chose to take monthly payments, there is a minimum initial withdrawal ($20,000). The interest rate charged for the reverse mortgage is 1.5% to 2.5% higher than the line of credit.
Eventually, after approximately 9 years, she would not be able to draw any more money from the reverse mortgage. She would not be required to make any minimum payments on the reverse mortgage.
With a Home Equity Line of Credit, she would be able to draw the full amount or she could draw a monthly payment to supplement her income. She would have to make a minimum payment every month to cover the interest cost. She could draw a little more each month from her line of credit to cover the added interest cost until her balance is equal to her credit limit.
There would come a time where she would not be able to draw any more funds and she would have to continue to pay interest.
For ongoing cash flow, the reverse mortgage is better. The home equity line of credit has a slightly lower interest rate but requires ongoing payments which could negatively affects her cash flow.
What happens with this same client after 10 years?
After 10 years, this client is now 80 years old. Let's assume she drew $20,000 initially from her reverse mortgage, then drew $1,500 per month to supplement her income.
Using 6.5%, her reverse mortgage balance would be approx $275,000. Assuming a home value increase of 2% per year, her home would be worth $609,000
Based on today's calculations & criteria, she could potentially qualify for an increase of her reverse mortgage. She could set up a reverse mortgage for $314,500.
Based on this example, she could draw out an additional almost $40,000 ($314,500 minus $275,000). She could also choose to take a monthly draw of $1,500 per month for almost 2 more years.
By utilizing a reverse mortgage, she could extend the life of her investments by drawing funds from her home as well as from her investments. She could also utilize the reverse mortgage for a lump sum payment to invest or to pay off debt or to pay for something she needs.
With this comparison, I assumed that the client would qualify for the home equity line of credit. If she had bruised credit or didn't have much income, she may not have qualified for the line of credit. In that case, her only option for mortgage financing would be a reverse mortgage.
Can I Get More Money After I Set Up A Reverse Mortgage?
A reverse mortgage is set up based on the value of your home and your age. If your home increases in value each year and your age, then you could qualify for more money than you owe on the reverse mortgage.
In the example that we reviewed earlier. This client would be able to get an additional $40,000 after 10 years of holding a reverse mortgage. Each situation is different and calculations are very difficult to predict, but it could be possible.
If you set up a reverse mortgage that allows additional withdrawals over time, then you could draw more funds provided you didn't draw out the maximum approved amount up front.
What Can I Use The Money For?
You can use the money from a reverse mortgage for anything that you would like. Some of the things that I have seen clients use a reverse mortgage for would include:
- pay off debt
- purchase/replace aging appliances
- complete some renovations
- develop a basement suite for rental income
- upgrade a kitchen
- purchase investments
- purchase another home
- monthly income (draw a little bit to supplement your income every month, note this money would be tax-free)
The money that you take from a reverse mortgage is your money. The bank will not tell you what you should or should not use the money for.
Can I set up a reverse mortgage on a rental or investment property?
Sort of... Today, both reverse mortgage lenders will only provide this type of financing on a principle residence. However, if you have a rental property you could finance your principle residence and the rental property at the same time with one big mortgage. It is called a blanket mortgage.
With a blanket mortgage, you could finance your own home (principle residence) and a rental property.
It's possible to blanket up to 3 properties, provided one of those three is your principle residence.
Case Study: Client with a Rental Property.
Let's look at a client who was considering a reverse mortgage. She owns a home worth $500,000 with no current mortgage. She owns a rental property with a mortgage of $150,000 and payments of $1,000 per month. She had been trying to pay this off and the payment is accelerated.
The rental property is worth $400,000, is a bungalow. She receives $1750 per month for rent. After expenses, she only sees approximately $200 per month net cash from the rental.
Her plan was to have a rental property that would supplement her income in retirement, but there is a long way to go before she will pay off that mortgage.
She decides to set up a reverse mortgage. She is approved for $310,000. She would pay off the rental mortgage and set up a recurring monthly payment of $1,500 from the reverse mortgage. She won't have to pay the rental mortgage anymore.
Her cash flow will increase by $3,250 per month ($1,750 plus $1,500) and based on calculations she can draw this $1,500 per month for almost 9 years. Because the reverse mortgage is blanketed over her home and the rental, her accountant is able to allocate a portion of the mortgage interest as tax deductible.
This example shows how much additional cash flow can be generated by restructuring your finances with a reverse mortgage.
Can I Qualify For A Reverse Mortgage If I'm Younger Than 55 Years Old?
No, you must be 55 years of age or older to qualify for a reverse mortgage. The younger you are when you apply for a reverse mortgage, the less equity you can potentially borrow.
If we compare two applicants who each own a home worth $500,000. The applicant who is 75 years of age will be approved for a higher percentage of the home's value than an applicant aged 55.