An objective look at reverse mortgages in Canada and how to know if they're right for you
The concept of reverse mortgages is clouded with confusion: Who is a good candidate for one, and in what situations do they make sense? Let's peel back the layers to discover what a reverse mortgage is, the advantages and disadvantages of this product and, above all, why, when and under what circumstances a reverse mortgage might be appropriate for you. But before you sign on the dotted line, get a second opinion from an accredited mortgage professional and know that you likely have other options. As Canadian finance columnist Rob Carrick once wrote, "The equity in your home is a terrible thing to waste."
Here's what you need to know.
1. THE BASICS
A reverse mortgage is a loan against the equity in your home. To qualify, you must be at least 55 years old and own your home outright or have a sizable amount of equity in it. You can borrow up to 55 percent of your equity, and you're not required to pay it back until you sell the home, move out or pass away (in which case, your estate will pay off the amount owed). If approved, you can receive the loan as a lump sum, scheduled payments or both. That money, plus any interest, can be paid back at any time; however, there will likely be a penalty if this is done within the first three years.
2. THE CHALLENGES
The longer you stay in your home after you take a reverse mortgage, the greater the drawdown on your equity, as the compounding interest on the principal can accumulate quickly. It's possible there will be little to no equity remaining when you leave your home—meaning less, if any, inheritance for your beneficiaries. However, neither you nor your estate is liable for any shortfall if housing prices drop and the outstanding mortgage balance exceeds the value of the home.
3. THE BOTTOM LINE
With a reverse mortgage, you'll enjoy tax-free funds and have the opportunity to stay in your home, but you'll greatly erode what is likely your largest financial asset and what may be your last source of financial independence. You'll pay higher fees and a higher interest rate than you would on a conventional mortgage. Most importantly, when you run out of the money you borrowed against your home equity, there may be no cash left after the sale of your house.
4. THE OTHER OPTIONS
A reverse mortgage is a good choice for people who want to access some of the equity in their home without the worry of repaying the mortgage while they're living there. If these realities don't resonate with you, consider an alternative solution. Think about selling or downsizing your home and putting the proceeds into a safe investment, then living off the income that it generates. This may also allow you to move into a retirement facility, if that's an option. If you're set on staying in your home, you might want to consider an equity line of credit, which is a secured loan; you're required to make interest-only monthly payments—at a much lower interest rate—and you don't have to pay off the balance until you leave your home.