Reverse Mortgages – There’s a Lot to Consider Before You Trade Your Home Equity for Cash
Q: My wife and I retired 3 years ago at the age of 62. We have modest pensions and have just applied for our Canada Pension and Old Age Security benefits. While we own our own home outright, we don’t have a lot of savings on hand. We had to subsidize our living expenses until we turned 65 and qualified for government pensions and benefits. We’re in need of a new car and we would like to fix up our home. We spoke to a representative about a reverse mortgage and we may qualify for a mortgage of up to $200,000. We’re tempted to borrow the funds since we don’t have to make any payments on the loan until we move or sell the house. Before we proceed, can you advise us of the disadvantages of a reverse mortgage? ~ Bill
A: Reverse mortgages have become increasingly popular in Canada because homeowners can turn some of the equity in their homes into cash and are not required to make regular monthly payments or pay off the loan until they sell their home. In the event the mortgage and interest balance exceeds the value of the home when it is sold, the homeowner is not liable for any shortfall. You also have the option to receive the proceeds of a reverse mortgage as a lump sum payment, planned advances to enhance your annual income or a combination of these options.
Disadvantages of a Reverse Mortgage
On the downside, the costs associated with this type of mortgage are high. You will be required to have your home appraised to determine how much money can borrow, you may pay an application or closing fee, and you are required to obtain independent legal advice before proceeding with the loan. There may also be a repayment penalty if you elect to sell your home within 3 years of obtaining a reverse mortgage.
Interest Rates on Reverse Mortgages & Loans, Risks to Your Home Equity
While the interest rates on reverse mortgages have come down in recent years, they are higher than most other types of mortgages. The other consideration to keep in mind is that all forms of debt, including reverse mortgages, carry some risk. The risk associated with a reverse mortgage is that the interest charges compound and will chip away at your equity over time. This may impact your future living arrangements if it is necessary for you and your wife to move into assisted living. At your death, the principal and interest owing on your mortgage must be paid in full, which will reduce the size of your estate and the amount of money available to your heirs.
Other Options to Consider Instead of a Reverse Mortgage
Before you go forward with a reverse mortgage, I encourage you to consider how much money you will need from the sale of your home in the future to manage the costs associated with assisted living or moving into long term care if your health declines. Long term care for seniors is expensive and you may be surprised at how much money you will need in order to maintain the quality of your life.
The other options to consider are downsizing to a smaller home to access some of your equity or taking out a secure line of credit using your home as collateral for the loan. With your monthly income increasing as a result of your Canada Pension and Old Age Security benefits, you may be able to manage the minimum payments required on the line of credit. Unlike a reverse mortgage, a line of credit has a set limit in place which means it won’t continue to impact your equity once your limit is reached.
Avoid Problems with a Reverse Mortgage - Calculate Your Budget First
These are sensitive issues to work through as you look at reverse mortgages and loans. Unfortunately too many people put these decisions off until they are stuck facing them when problems arise or they are in a crisis situation. Take the time now to discuss these matters while you are in good health, of sound mind and looking forward to your future.
I also recommend that you track your spending, identify seasonal/annual expenditures and set a budget to help you manage your income and expenses going forward. This will help you to avoid the temptation of paying for additional expenses with credit. A budget calculator can help you consider various situations as you consider all of your options.
The Bottom Line on Reverse Mortgages - Consider All Options & Alternatives That Don’t Chip Away Home Equity
By investing some time now to look at your future needs and consider all of your options and alternatives, you will be able to determine if a reverse mortgage that chips away at your home equity is the right solution for you today, with no regrets later on.
Related articles:
- Help a Senior Parent Budget & Manage Money
- How to Get Out of Debt Before Retirement
- Prepare for Unexpected Expenses