I've found that when people talk about Reverse Mortgages, there are far too many myths and misconceptions. Typically, clients will call on behalf of their aging parents.
Their parent's incomes are not keeping up with inflation. They want access to the equity in their home but aren't ready to sell.
The main advantages (pros) of a reverse mortgage is that you can stay in your home longer without increasing your monthly expenses. It's also relatively easy to qualify for a reverse mortgage. The main disadvantage (con) is that when you access the equity in your home through a reverse mortgage, the interest is potentially eating away at your equity.
These are the two main benefits but I thought we should explore all the pros and cons in more detail. If you are reading this article then you are either reading about reverse mortgages for yourself or a loved one.
I would recommend that you also read the article I wrote on this website called: How Does A Reverse Mortgage Work?
What are the advantages of a Reverse Mortgage?
- Stay in your home longer
- Increase your cash flow by drawing an income
- Increase your cash flow by paying off debt
- Help with tax planning
- Provide an early inheritance to loved ones
- Charitable giving
- Renovate your home to make it more accessible or build a basement suite
- Use a Reverse Mortgage to purchase a smaller home and keep more equity from the sale of your current home
- Draw out only the equity that you need
- You qualify no matter what your credit score is
- You qualify no matter what your income is
1. Stay In Your Home Longer
Staying in your home longer is the biggest benefit of a reverse mortgage. Many Canadians have worked hard to pay off their mortgage and own their home outright for retirement.
Your home is probably your biggest investment. When you retire, you stop earning an income and you start to draw on your investments to replace your income. If your home is your largest investment, then it's time to start using the equity in your home to maintain your lifestyle.
One way to get the equity out is to sell your home and downsize. If you purchase a home that is worth half the amount of your current home, then you will free up cash.
You can use this cash for anything you want. When you sell your home, you receive the money tax-free.
Another option is to sell your home and rent a home. Selling will free up all the equity that you have built up in your home but you will now have monthly rental payments. There is also potential risks that your landlord could sell the home and you will have to find another place to live.
There's a problem with these "selling" options above.... You have lived in your home for so many years. You are comfortable there. You have neighbors and friends who live close by. You're not ready to move!
One alternative to selling your home is a reverse mortgage. You can get access to the equity in your home by taking out a mortgage. The reverse mortgage has no required payment, therefore you can use this money and you don't have to make monthly payments.
The reverse mortgage allows you to stay in your home while accessing the money that you worked so hard to save over your working life.
2. Increase Your Cash Flow by Drawing an Income From Your Home's Equity
The reverse mortgage is designed for older Canadians. The minimum age for a reverse mortgage is 55. However, on average Canadians don't consider a reverse mortgage until their late sixties to early seventies.
If you're in your late sixties to early seventies, you will receive Canada Pension Plan (CPP) and Old Age Security (OAS). This pension income will increase a little each year with inflation, but sometimes it doesn't keep up with your expenses.
You can set up a reverse mortgage in a couple of different ways:
- Setup the reverse mortgage and draw the full amount
- Setup the reverse mortgage and draw small amounts over time
Let's use an example to better illustrate this. A retired couple, both aged 71 years own a home worth $500,000. They have no mortgage and they set up a reverse mortgage for $200,000.
Option 1: Draw all the money ($200,000) upfront
They draw all $200,000 and deposit the funds to their savings account. They use some of the money to pay credit card debt. They purchase a new washer and dryer, their current washer is over 10 years old and stopped working.
They are having trouble walking up and down the stairs and have a lift installed with some other renovations. They have $125,000 leftover. This money stays in their bank account and they could draw on it as needed over time.
The reverse mortgage doesn't require any monthly payments. The interest due on the reverse mortgage would accrue over time. The interest that accrues would be calculated based on the $200,000 that was drawn out.
Option 2: Draw $75,000 for home improvements.
With this option, they draw just $75,000 upfront. Like option 1, they pay off debt, purchase a washer and dryer, install a chair lift and other renovations.
No payments are required for the reverse mortgage. The interest is accrued on the reverse mortgage based on the amount drawn, which is $75,000. They also have access to $125,000 in the future if needed.
After 3 years, they wanted to take a vacation and pay for their grandkids. There are a couple of other things they also want to do. They draw $25,000 from the reverse mortgage. They now owe $100,000 plus accrued interest on the reverse mortgage.
After taking out $25,000 from the reverse mortgage this year, they now have access to $100,000. One thing to note, they accrued interest does not affect the amount they have available.
This couple was approved for $200,000 and can draw out a total of $200,000 over time without calculating accrued interest.
Another item to note, the accrued interest in option 2 is calculated on the amount used. Therefore over time, there is less accrued interest compared to drawing the full amount upfront.
Option 3: Couple Draws $75,000 for Home Improvements & Sets Up a Monthly Withdrawal
With this option, the couple decides to draw $75,000. They use the money to pay off debt, complete renovations including a stairlift a walk-in tub and bathroom upgrades. They also replace some of their aging appliances.
They find that the pension income isn't quite enough to cover all of their expenses. They decide to set up a monthly withdrawal from the reverse mortgage for $1,500. This will give them additional tax-free income and they won't have to draw on their savings quite as rapidly.
As you can see from these three examples, this retired couple have choices and options when they set up the reverse mortgage.
In all cases, they only accrue interest on the balance that is outstanding. When they choose option 2 or option 3, the interest accrues more slowly than if they chose option 1.
3. Increase Your Cash Flow by Paying Off Debts
Debt consolidation has been one of the main reasons, over the last few years, that clients take out a reverse mortgage. With increasing costs and a fixed income, seniors often turn to credit cards to cover expenses.
High-interest rates and costs of credit card quickly build up and seniors start looking for solutions. A reverse mortgage is a good option to pay off credit card debt. The interest rate for a reverse mortgage is much better than credit card rates.
With a reverse mortgage, you don't have to make monthly payments. This can help ease your cash flow substantially.
Late payments and missed payments on credit cards will not affect your ability to qualify for a reverse mortgage.
If you read the last example of a couple who set up a reverse mortgage for $200,000, then we could use the same here.
Let's assume the couple own a home worth $500,000. They are both 71 and earn $44,000 combined. They have a total of $75,000 of credit card and personal loan debt. They qualify for a reverse mortgage of $200,000.
This couple would have the same options as in the previous section. They could draw out the full $200,000. They could pay off the debt and deposit the balance into their bank account.
If they have been struggling with cash flow, then they could pay off the debt and then set up monthly cash flow from the reverse mortgage. This can help them to cover their expenses in the future and will reduce the total amount of accrued interest over time.
4. Help With Tax Planning
A reverse mortgage can be utilized as a tax planning tool. If you have investments but don't want to draw on them right away, you could utilize a reverse mortgage for income.
You could also use a reverse mortgage to grow your investment portfolio without having to make payments to the reverse mortgage.
When you draw payments through a reverse mortgage, the payments can act like income without the income taxes associated.
Financing, like a reverse mortgage or home equity line of credit or traditional mortgage, can often help retired clients to stay in their homes. The more money you can draw to live on without paying additional or excessive taxes the better for you.
I'm not suggesting that a reverse mortgage is the best option for retired clients, but tax planning should be holistic. You should review all your assets, your investments, and properties that you own. A holistic approach that includes your principal residence can open some doors and options that you may not have thought possible.
5. Provide an Early Inheritance to Loved Ones
In some cases, you want to provide your loved ones with a gift. With a reverse mortgage, you can potentially provide that gift early. You can watch them enjoy your financial gift, instead of waiting until you have passed to provide it.
A reverse mortgage can be an excellent way to draw out some funds that you aren't using for your day to day expenses. The reverse mortgage doesn't require monthly payments and you get to see your loved ones benefit while you are alive.
6. Give to Charity
Along the same lines as providing an early inheritance, you could provide a gift to charity by utilizing a reverse mortgage. You can get access to additional funds by setting up a reverse mortgage.
You can then give these funds to the charity of your choice and get the pleasure while you are still alive. One thing to note, often charitable giving is combined with some tax planning and estate planning.
When you give to charity, there are tax benefits that you will receive. It's really important to work with your financial planner or accountant to ensure that you maximize your gifts and minimize the amounts that go to the government for taxes.
I'm not suggesting that we should avoid tax. They should receive a fair share. Our government has set up rules and programs that help Canada to be a great place and it does cost money for these things.
You have also spent a lifetime growing your wealth and when you want to give it to charity or loved ones, or whomever, make sure you maximize your gifts through planning.
7. Renovate Your How to Make it More Accessible or Build a Basement Suite
As we age, mobility can become an issue. To stay in your home, you may have to make modifications. A reverse mortgage is a fantastic way to get cash to make the modifications that you need. This can also increase the value of your home, in some cases.
If you need a caregiver, you could utilize some money from a reverse mortgage to build a basement suite for your caregiver to stay.
I have worked with seniors who didn't need a caregiver right away, but they decided to build a basement suite anyway. They rented out the basement suite and generated an additional $900 per month of income. They can write off the interest on the reverse mortgage, even though they aren't making any interest payments.
When the time comes that they will need an in-home caregiver, they have the suite in place. They can evict the tenant and have the caregiver move in.
This situation created a real win for this couple. They generated a little extra cash flow in the short term and had a suite for a caregiver if needed in the future.
The couple hadn't thought of this option if it wasn't for friends of theirs. One of their friends slipped and broke a hip. His hip never really healed properly and his wife couldn't help the way she wanted to.
They looked at options and a live-in caregiver was something the liked. The build a basement suite for the caregiver and this allowed them to stay in their home longer.
The couple in our example above decided to set things up so that they would have a suite in case they needed it. They didn't have to rush things, they rented the suite and now have something in case things change.
8. Purchase a Smaller Home and Keep More Equity From The Sale of Your Current Home
For some reason, people don't realize that a reverse mortgage can be set up on a home you own or a home that you wish to purchase. If you are in the process of downsizing, you can use a reverse mortgage to keep more of the equity from your first home.
This is a really good time to set up a reverse mortgage. Let's look at an example where a couple downsizes and pays cash for a home versus using a reverse mortgage.
Let's assume our couple own a home free and clear worth $500,000. Let's assume that they could set up a reverse mortgage for 50% of the value. They plan to downsize and purchase a home worth $350,000.
If they purchase the new home with cash, they would end up with approximately $150,000 cash to invest. They wouldn't have mortgage payments. They could use the $150,000 for anything they wished.
If they purchased a new home and set up a reverse mortgage, they would use $175,000 cash from the sale. They would also set up a reverse mortgage for $175,000. There would be no required mortgage payments. The cash flow would be the same as a cash purchase.
However, they would have a total of $325,000 in cash to invest. ($500,000 minus $175,000 to purchase the home).
The thing about the reverse mortgage, they can set it up then draw monthly payments instead. In this second example, the couple could have set up quarterly payments or monthly payments instead of taking all the cash.
If for example, they decided to draw $17,500 per year (approx $1450/month), then they could draw this income for 10 years.
In this example, they would pay $350,000 cash for the home, leaving $150,000 to invest. They would set up a monthly payment of $1,450 from the reverse mortgage for 10 years. The $150,000 cash could be invested and grow for 10 years. Then they could use this money for further cash flow after 10 years.
There are so many options with a reverse mortgage, you should speak with a mortgage broker who is familiar with how they work. You can compare and contrast a traditional mortgage with a reverse mortgage versus a home equity line of credit. Then you can choose the option that's best for you.
9. Draw Out Only The Equity That You Need
I touched on this in the last advantage of a reverse mortgage. When you set up a reverse mortgage, you have choices and options.
You can take all the money upfront, which many people do. You can also draw some money. Then draw more next year. Then not anymore for a few years, then draw a little more again.
Another popular option is to draw an income instead of a lump sum. When you set this up, you do have to draw a minimum amount of $20,000 upfront. After that, you can draw a monthly or quarterly "income".
I use income in quotes because you are drawing equity, it's your money. There is no tax. It's like drawing money from the cash in your bank account. Except, with a reverse mortgage, your bank account is your home's equity.
Let's look at an example. A couple owns a home worth $500,000. They can finance up to 50% of the value. They decide to take a little to catch up on repairs, then draw a monthly income.
The reverse mortgage is set up for $250,000. They draw $20,000 for the home improvements. They also set up payments from the reverse mortgage for $1,250 per month.
This allows them to have an additional $15,000 per year of cash flow, from their home equity for 15 years.
The extra cash allows them to do a few more things. They could afford everything with the income that they were earning, but this extra allows them to take a few extra holidays and not have to draw so much from their investments where they would pay taxes.
A reverse mortgage can be set up in 3 ways. 1. You can draw the full amount. 2. You can draw some every year 3. You can set up a regular payment (monthly or quarterly).
This allows you the flexibility to use the money the way you want and to stay in your home longer (which is the #1 benefit)
10. Your Credit Does Not Affect How Much You Qualify For
Most seniors have good credit, but sometimes things happen. When you have a set pension income and costs keep going up, your credit could be affected. The advantage of setting up a reverse mortgage is that your credit will not affect your ability to qualify.
I've met with several seniors who have been struggling to keep up with all the increasing costs of homeownership. They've started using credit cards to cover their costs and some payments have been missed.
When we set up a reverse mortgage for these clients, they can pay off their credit cards. That often frees up the cash flow that they need. They can also draw out additional funds regularly to help with increasing costs.
The reverse mortgage qualification process does not discriminate. If some of your credit cards are in arrears, you can still qualify. If your credit is bumped and bruised, you can still set up a reverse mortgage.
11. Your Income Does Not Affect How Much You Can Qualify For
One of the advantages of a reverse mortgage is the qualifying criteria. When you apply for a reverse mortgage, the main qualifying criteria is your home's value and your age.
Unlike most other mortgages, your income isn't a factor in how much equity you can get access to from your home. Many seniors set up a reverse mortgage to provide an increased cash flow. Effectively, providing a little extra income every month, or every quarter, or every year.
What are the Disadvantages of a Reverse Mortgage?
- Potentialyl lost equity due to compound interest
- Set up cost is more than a traditional mortgage or Line of Credit
- You may not get as much as you want or need
- The penalty can be large if the mortgage is paid out in the first three years
1. Potential Lost Equity Due to Compound Interest
The biggest concern that I hear from clients is that they could lose their equity. One myth I've also heard is that the clients lose their homes. This is just NOT TRUE.
First off, when you are approved for and set up a reverse mortgage, the lender will register a mortgage on title. They do not take your name off the title. They register a mortgage, just like every other mortgage lender. The home will be in your name until you sell it or change that.
Let's look at how the compounding interest works through a couple of examples.
A couple owns a home worth $500,000. They are approved for a reverse mortgage of $250,000 and draws all the money. Let's assume their home increases in value by 2% each year and the interest rate on the reverse mortgage is 6%.
When this couple starts, they take $250,000 cash out to use, spend, etc. They have $250,000 equity remaining.
After 10 years, the home has increased in value to $609,500. The reverse mortgage has increased to $451,500. They have approximately $158,000 equity remaining in their home.
Let's look at another example with the same couple, except in this case they draw out money as an income over the next 10 years.
The couple owns a home worth $500,000 and set up a $250,000 reverse mortgage. They draw $50,000 initially then $1,500 a month thereafter. The interest rate is the same, 6%. The home is assumed to increase in value by 2% per year.
After 10 years the couple has taken a total of $230,000 of equity from their home. $50,000 initially plus $18,000 per year for 10 years.
With accrued interest, the total mortgage balance after 10 years is $336,400. The home has increased in value to $609,500. This couple has $273,100 of equity remaining in their home.
As you can see in both examples, the couple still had equity in their home after 10 years of using the reverse mortgage.
2. Setup Cost is More Than a Traditional Mortgage or Line of Credit
The setup costs for a reverse mortgage are a little higher than setting up a traditional mortgage or a home equity line of credit. As a ballpark figure, you would be looking at costs of $1,000 to $1,500 more to set up the reverse mortgage. This range would be compared to a bank or credit union or trust company.
If you had bruised credit and no income confirmation, then the costs to set up the reverse mortgage could be substantially lower than arranging alternate financing or private financing.
Because the qualification process doesn't depend on income or your credit, the reverse mortgage is a good deal if you have bruised/bad credit.
3. You May Not Get as Much as You Want or Need
The maximum financing that's available with a reverse mortgage is up to 55% of your home's value. This percentage is based on your age. To qualify for the max, you will be over 80 years of age.
If you are in your sixties or seventies, you will not qualify for the maximum 55% and therefore may not get as much as you might need.
The reverse mortgage is just one potential option for older applicants to arrange for financing. It is possible to arrange a traditional mortgage, even if you are 85 years of age.
If you want to get access to the equity in your home without selling, then it's best to speak with a professional, like a mortgage broker, who can provide all the options.
If you just speak with a company that offers reverse mortgages, then your answers will be based on that product only. You may find that a home equity line of credit or a traditional mortgage better fits your needs.
4. The Penalty Can be Large if The Mortgage is Paid Out in the First Three Years
Two lenders in Canada offer reverse mortgages. Both charge large penalties if the mortgage is paid out in the first 3 years. A reverse mortgage is not a short term solution.
If you want to get access to equity in your home but plan to sell your home in the next 3 years, then I would not recommend a reverse mortgage. There could be other financing solutions that you could utilize instead of a reverse mortgage.
We have quite extensively reviewed the pros and cons of a reverse mortgage. I hope that you found this useful. If there are questions you have or more information that you would like, please connect with us.
You call or email, visit our contact us page for more details.