With many Canadians heading toward retirement carrying debt, those who own homes may be forced to turn to their lodging for extra income. But some may not be eligible for home equity loans, leaving them with choices that include downsizing or a reverse mortgage.
A recent survey on debt by Manulife Financial Corp. found that almost one in five Canadians expect to tap into home equity to top up their retirement income. Ten per cent of the respondents said they plan to remain in their houses and borrow against home equity, while a further 8 per cent are considering downsizing and using the extra equity to generate retirement income.
The Manulife poll, conducted online by Research House in September, surveyed 2,373 Canadian homeowners in all provinces between ages 20 to 59 with household income of $50,000 or more.
Both options come with their own set of pros and cons, and there is no one-size-fits-all option.
"It just depends on all the other factors in your situation," says Daryl Diamond, a Winnipeg-based financial adviser and author of Your Retirement Income Blueprint.
Canadian Home Income Plan (CHIP) reverse mortgages, have been available to Canadians older than 55 since 1986 through the country's sole provider, HomEquity Bank. The company reports a 23-per-cent year-on-year increase in new mortgages at the end of 2014, accounting for $309-million of a total company portfolio in excess of $1.7-billion.
With a reverse mortgage, borrowers remain in their house and maintain ownership, no payments are due until they move or sell, and they will never owe more than the market value of the property. In addition, there is no income or credit check, the money can be taken out in a lump sum or instalments and the loan can never be called. On top of that, the money is tax-free, and if it is invested, the interest on the loan becomes tax deductible, making investment a tax-efficient use of a reverse mortgage.
On the flip side, the interest rates are higher than those of a regular mortgage – HomEquity Bank had rates of prime plus 1.25 per cent as of last month – the interest compounds and can grow substantially if it is held for many years and there is a three-year minimum contract with penalties for discharging the mortgage before that. In addition, there's a price tag on taking out a reverse mortgage, with legal, home appraisal and administration fees all something to consider.
Though the amount of equity that can be borrowed has been capped at 50 per cent of the property's value, according to HomEquity Bank, some consider the gamble too great.
"Canadians tend to view their household equity as an ATM machine and they think that property values will continue to increase, says Brian Betz, a financial counsellor with Money Mentors in Calgary. "They might on a short-term basis, but as a retiree in that situation you cannot replace that asset," he cautions.
"We think it is basically taking on too much risk because everybody is waiting for interest rates to rise and when interest rates rise, property values will fall."
But for some people, taking out a reverse mortgage makes sense. George Gentile, president of Gentile & Associates Wealth and Estate Planning Group Inc. in Toronto, describes reverse mortgages as "a last line of defence." He describes the ideal reverse mortgage candidate as someone who has determined that they will live in their house until the day they die and their need for money now is greater than their desire to leave money for beneficiaries.
"The best situation for the reverse mortgage through HomEquity Bank is in a long-term estate situation," he says. "So you're in your 70s, 80s, you've run out of registered assets and you might need extra care … it's an ideal product for those types of situations."
The option to downsize is another method to free up income, and is a good option for those with non-financial reasons, such as empty-nesters who want to spend winters down south, or those who want to live somewhere that involves less upkeep, or in places that may have a little more security, such as a condominium.
"I would say that in the vast majority of cases that we have worked with that have downsized, the money has been a secondary thing," says Mr. Diamond. "It's more a lifestyle decision – we don't need four bedrooms any more."
But if unlocking financial value is the main consideration, now is the time sell, Mr. Betz says. "The current economic environment is historically low interest rates and high property values, so we would want to see you basically lock in the value of your nest egg by selling that property and then creating a holistic plan with the proceeds of that property to then carry you through to the end of life."
However, downsizing may not free up as much as owners think it will. The costs involved in making a move include real-estate fees, legal fees, land transfer tax and moving expenses.
In other words, if a home owner moves from a $700,000 property into one worth $400,000, it doesn't generate $300,000 net with all the disbursements.
And there are also practical drawbacks, such as moving away from a support system of friends and neighbours, or moving farther from doctors and hospitals.
"The problem is, particularly with older clients, there's that familiarity, that comfort in living where you are, knowing your home, and downsizing is not an option because you're simply not comfortable with doing that," Mr. Gentile says.
Another option to generate income without downsizing is to rent out space in the house, which is something that CARP, which was founded as the Canadian Association for Retired Persons, suggests as an alternative. However, as CARP readily admits, that comes with its own set of drawbacks, ranging from renovation costs to privacy and security issues, and maintenance costs and inconveniences.
If a home owner does downsize, however, it is crucial to develop a plan for those funds so they can generate additional cash flow, Mr. Diamond cautions.
Get help deciding
To help those considering the pros and cons of reverse mortgages, Web-based tools do exist to assist in making the decision, but the overriding opinion of experts is that this decision is too important and underpinned by too many different factors to simply punch in some numbers and expect a tailor-made, black-and-white answer.
"You can't do this over the Internet," Mr. Diamond says. "Every situation is so unique in terms of specifics and so different in terms of the appropriate resolutions or solutions to different issues.
"That's what … makes it very difficult and confusing for a lot of people who are trying to assess what the best course of action is and doing it in the isolation of one set of factors only."
Because of this, he recommends people considering this decision, or other options, consult with a professional.