With the average home in Canada now worth about a half-million dollars — and much more in large cities such as Toronto and Vancouver — it’s not surprising that some older homeowners are looking to reverse mortgages to unlock the equity that has built up in their properties. Indeed, average home prices in Canada have increased by more than 58% in the past 10 years, and by more than 222% since 1999.
While a reverse mortgage is certainly one way to access that equity, it’s not the only — or necessarily the best — option. Here’s what you need to know about reverse mortgages, and what alternatives exist for homeowners who want to free up some of the cash invested in their homes.
What is a Reverse Mortgage?
As the name implies, a reverse mortgage is the opposite of a traditional mortgage. Instead of borrowing money to purchase a home, you use the value of the home you already own as collateral to borrow money.
Just like a regular mortgage, the lender charges monthly interest on the amount you borrow. The difference with a reverse mortgage is that you don’t have to repay the loan or pay any interest charges until you sell the home, or you (and any co-owners of the home, such as a spouse) die.
To get a reverse mortgage, the homeowner(s) must be:
- Age 55 or older;
- Living in the home for at least six months per year.
The amount of money you can borrow through a reverse mortgage depends on the following factors:
- Where the home is;
- The age(s) of the homeowner(s);
- The value of the home.
Usually, the most you can borrow is 55% of the value of the home, either as a lump-sum one-time payment, or a portion of money upfront and the rest over a period of time. If you have any other debts against your house (like a secured line of credit or lien), you must pay those off with the funds you get from the reverse mortgage. Generally, the older you are, the more you can get from a reverse mortgage since the lender anticipates you’ll have less time to spend it all.
The Downsides of a Reverse Mortgage?
A loan that requires no monthly payments may sound like a dream, but it can turn into a nightmare in some situations. That’s because the interest charged on a reverse mortgage is much higher than on a standard mortgage or another type of secured loan. And since the borrower isn’t making any payments, those interest charges are added to the outstanding loan and can compound very quickly over time.
Before you know it, you could deplete the equity in your home — which would make it difficult if not impossible for you to consider selling and moving to a smaller space. And, if you hold on to the property until you die, your children or other heirs may not be left with anything at all.
Other cons of reverse mortgages include:
- Fees: In addition to paying a higher interest rate, you may also have to pay for a home appraisal, application fee, closing costs and other legal fees (your lender may require you to obtain independent advice before granting you a reverse mortgage).
- A limited number of providers: There are only two financial institutions in Canada that issue reverse mortgages: HomeEquity Bank (the Canadian Home Income Plan) and Equitable Bank (PATH Home Plan).
- Potential problems for your estate: If you stay in the home until you die, your estate must repay the reverse mortgage loan and all interest charges in full within a specified amount of time. But the time required to settle the estate could be much longer than that, which could create financial difficulties for your heirs upon your death.
Is a Reverse Mortgage Ever a Good Idea?
In most situations, homeowners would be better off getting a secured line of credit, or Home Equity Line of Credit (HELOC), which is another type of borrowing that uses your home as collateral. Why? Because many lenders offer much lower rates of interest on a secured line of credit than you could get on a reverse mortgage. motusbank*, for example, is currently offering rates as low as 3.75% on a secured line of credit, as compared to well over 5.5% interest for a reverse mortgage.
Of course, going with a line of credit requires the borrower to make a minimum monthly payment — usually equal to the amount of interest. But that’s a good thing because those interest charges won’t snowball and erode the equity in your home. Plus, with a HELOC, you have the freedom to pay back the money you’ve borrowed at any time, which could potentially save you big time in interest charges over the long term.
Aside from not having to make any payments until you sell the home or die, there are a couple of other selling points for a reverse mortgage vs. HELOC.
- You don’t need to prove your income to qualify. As stated above, any homeowner over the age of 55 who lives in their home at least six months a year can qualify for a reverse mortgage. To qualify for a HELOC, however, requires proof of stable and sufficient income and an adequate credit score.
- You will never owe more than the value of your home. If housing prices suddenly drop, there’s a possibility with a HELOC that you could owe the lender more than the home is worth. According to the rules of a reverse mortgage, however, you and your beneficiaries will not have to worry about such a shortfall because the amount owing on a reverse mortgage can never exceed the property value.
*Disclaimer: This offer is not available for residents of Quebec.
Alternatives to a Reverse Mortgage in Canada
Before taking out a reverse mortgage, consider some of these other ways to unlock the equity in your home:
- Get a secured line of credit/HELOC. As explained above, this type of borrowing is usually much cheaper than a reverse mortgage. You can access up to 65% of the equity in your home while you continue to live there and maintain ownership.
- Become a landlord. Turn your home into a source of income by renting out a room or a basement apartment.
- Downsize. You could sell your home and buy a smaller place, move to a cheaper location or invest the equity and rent.
A Final Word
Weighing the pros and cons, a low-interest loan with a leading lender may be the best option for many Canadians. However, if you decide a reverse mortgage is right for you, be sure to ask your lender about all the associated fees, what rate of interest they will charge, if there is a penalty charge for selling your home, and how much time you/your estate will have to repay the loan when you move/die.