Real estate rich; cash poor: Retirees who need to free up some money may be eyeing their real estate.
A reverse mortgage is one option, but experts caution home owners to make sure they understand both the advantages and disadvantages of that decision
Whom is it for?
For those looking for a short-term injection of cash, for those 55 and over looking for extra income and who are planning on living in their homes for many years and are less concerned about leaving a legacy, it could be an avenue worth exploring. Other options include a line of credit or downsizing.
The scenarios they face could be that their portfolios took a hit in a market downturn, they have unexpected medical expenses, or even that they would like to help out younger family members with education or home purchases.
"The first question I ask my clients when we approach the issue is, 'Is this the last place you're going to be living in, and do you want to be carried out of this house feet first?' " says George Gentile, president of Gentile & Associates Wealth and Estate Planning Group Inc. in Toronto, who has been advising seniors on the dos and don'ts of reverse mortgages for the past 19 years.
Mr. Gentile says that for those who can answer yes to that question, a reverse mortgage is something to be considered. However, he does consider it a "last-resort type of financial product," aimed specifically at those whose need for money in the here and now outweighs the desire to leave money for beneficiaries.
What is it?
A reverse mortgage is for those over 55 who have enough equity in their home and want to keep living in it. They can get from 20 to 50 per cent of a home's value, depending on their age, location, existing secured financing and property type. HomEquity Bank's Canadian Home Income Plan (CHIP) is Canada's only widely available reverse mortgage. But applicants can apply for one through banks, mortgage brokers and financial advisers.
Borrowers can receive the money in a lump sum, or monthly payments. They can never owe more than the value of their home. Though they can start repaying their home while still living there, they do not have to make repayments while they are still alive or until they move or sell the home, and they will not be forced to leave their homes.
One advantage of a reverse mortgage is that borrowers are protected from a rise in interest rates and a drop in property value, meaning that they won't be asked to make up the shortfall. And it doesn't necessarily result in complete erosion of the equity in their real estate.
In fact, Neil Shopsowitz, who is a licensed mortgage broker with Dominion Lending Centres in Vancouver, says that the current rate of increase in real estate values can help offset the interest homeowners can pay for the right to remove some of the equity in their home via a reverse mortgage.
"[Let's say] you're borrowing 33 per cent of the value of your house and interest is accruing at 5 per cent, your house is still appreciating 100 per cent the value of your home," he says. "If we take the 20-year average of 2.5, 3 per cent [growth in property values], if you graph it out, your equity in your home is not eroding, it's still increasing, albeit at a slower rate."
But because interest accrues as long as homeowners do not make payments on the loan, and early repayment can come with penalties, one of the concerns with reverse mortgages is that they will run through all the value of the home.
"The biggest fear in the reverse mortgage is the capitalization of the loan so the interest accrues on it and you don't have to pay it back, so at what point in time do you erode totally the value of your property and the equity in the property?" Mr. Gentile says.
But "It's very good market for this type of product," he adds. This is especially the case given the current sky-high prices of real estate in Canada's large urban areas, prices that Bank of Canada governor Stephen Poloz has said are overvalued by up to 30 per cent.
"When you're dealing with a property in the GTA that's appreciating by more than 6 per cent annually, there is not a big risk of that." Mr. Gentile says.
Tax-free income, with fees
One of the distinct advantages of a reverse mortgage is that it offers tax-free income, so it does not affect income-rated benefits such as Old-Age Security or Guaranteed Income Supplement. However, it also comes with heavy penalty fees for early repayment and the start-up fees and interest rates on a reverse mortgage are more costly than those associated with a traditional mortgage. Closing fees can be up to $1,495, and there may be other fees; and interest rates run as high as 5.95 per cent, according to HomEquity Bank.
"The reason why people consider a reverse mortgage is because they can't get an ordinary mortgage, they can't draw on a line of credit, because the banks say, well, you have no income stream to support repayments," says Susan Eng, vice-president of advocacy for CARP, which was founded as the Canadian Association of Retired Persons. "Hence we can allow you to take down the equity in your house, but at high rates, so more than your neighbour would who takes out a second mortgage on their house."
The importance of saving
As a result, Ms. Eng is a big proponent of planning ahead, saving as much money as possible, and also taking out a line of credit before retirement to deal with any eventualities that may happen down the road, and avoiding reaching the point where "you're stuck with the only option being amortizing your house."
But, "It really is a great product in the sense that it prevents people from having to go to private mortgage lending, where the rates would be considerably more," says Kam Brar, a mortgage planner with Auxilium Mortgage Corp. in Victoria.
"This is a really good option for somebody who wants to stay in their home, have some cash flow and enjoy their retirement years, not have to be stressed about making monthly payments and who wants a little more freedom in the last years of their lives.
"I think the biggest thing that people need to be aware of is make sure that they understand exactly what they're getting into as far as the whole process," Mr. Brar adds. "What is their outcome out of this, because a reverse mortgage is not going to be for everyone. It's just a question of figuring out the long-term cost in relation to what their long-term plans are."