In their 60s with their house their main asset, Milo and Maeve are finding it tough to get by on government benefits alone. Maeve is age 66, Milo 69. They both earn a little extra working part-time.
“There is about $410,000 in equity in our home, but we are low income seniors and can’t get a line of credit,” Maeve writes in an e-mail. “We have no private pensions, investments or dividends.” Their situation is not unusual.
They are hearing conflicting reports about reverse mortgages, “but for a couple like us, with no kids to worry about leaving money to, it seems to make sense,” Maeve writes.
“We would like some cash on hand for expenses like vet bills for our kitties, new eyeglasses for each of us and perhaps the occasional short trip.”
Their goal is to stay in their house as long as possible by “adapting it to our needs as we age,” she adds. That entails adding a main floor bathroom.
Because they are an hour or so from Toronto, the rental market in the small town where they live is “incredibly tight,” Maeve adds. They don’t want to sell, “but we don’t have a nest egg to help with unforeseen home costs like the new furnace we just got!”
Does a small reverse mortgage make sense?
We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Maeve and Milo’s situation. Mr. MacKenzie holds the certified financial planner, chartered professional accountant, and chartered investment manager designations.
What the expert says
“For many people, a successful retirement comes from keeping busy, enjoying one’s home and neighbourhood, living in the moment and making the right financial choices,” Mr. MacKenzie says. For Maeve and Milo, though, living on a fixed income has been constraining so they have an important choice to make.
“They’re struggling to make ends meet,” the planner says. Their monthly cash outflow is about $4,300. The inflow from Canada Pension Plan, Old Age Security, the Guaranteed Income Supplement and part-time work is $3,900 a month, leaving them with a shortfall of $400 a month. “This is not a huge deficit, but month after month it adds up,” he says. Occasional car expenses, a new appliance, and veterinary bills only add to their financial woes.
The cash flow problem has existed for a few years, Mr. MacKenzie says. “When they last renewed their mortgage, they increased it by enough to pay off their credit cards and give themselves a cushion,” the planner says. “That cushion has been used up and they’re no longer able to get a larger conventional mortgage.”
With their house recently appraised at $600,000, and an existing mortgage of about $190,000, they have home equity of about $410,000. Their only investment is $500 in a tax-free savings account. They have credit card and income tax bills totalling $3,400.
“Aside from the cash flow problem, Milo and Maeve are enjoying retirement,” Mr. MacKenzie says. “They love their home and garden and living in a community where their friends live,” he says. “Their part-time work for a few hours each week gives them a small amount of cash and a real sense of purpose.” Most evenings they enjoy sharing a bottle of wine with dinner, watching a movie and playing with their two cats.
Next year, they want to spend $20,000 to put a bathroom on the main floor to make it easier to “age in place.” When the time comes, if it’s necessary, they’re okay with moving to a government-subsidized nursing home, the planner says.
To solve their cash flow problem, Maeve and Milo have some options.
They could sell their house and rent an apartment, but they don’t want to and rents in their town are high and rising, the planner says. If they sold and invested the proceeds, any taxable income earned on their investments “would result in a significant reduction in their guaranteed income supplement,” he says.
An alternative would be to reduce their discretionary spending. “They can stop drinking wine with dinner, give away their pet cats to save pet food and vet costs, cut back on the movie channels they subscribe to, and spend less on their flower garden and groceries,” Mr. MacKenzie says. “This would solve the cash flow problem, but they’d be giving up many things that now make their lives enjoyable.”
Or they can take a reverse mortgage large enough to pay off the existing debts, including the cost of the new bathroom. “By not having to make the monthly payments of $1,005 on their existing mortgage, they’ll be able to enjoy their home and lifestyle more.”
Maeve and Milo understand that with a reverse mortgage, the compound interest will eat into their estimated $410,000 in home equity. “If we assume 2-per-cent inflation and a 7-per-cent interest rate on a reverse mortgage large enough to pay for the new bathroom and retire the existing debts – and if they make no monthly payments – in 10 years time the reverse mortgage will be about $425,000,” he says.
Over the same 10 years, if their house increases at an average annual rate of 2 per cent, it would be worth about $755,000. “So, in nominal dollars, the equity in their home would be reduced to about $330,000.” If inflation averages 2 per cent per annum, in 10 years time this $330,000 would be worth about $270,000 in dollars with the same purchasing power as they have today, the planner says. This means that over 10 years their net equity will have decreased by about $140,000 (net equity today of $410,000 minus net equity adjusted for inflation of $270,000 in 10 years).
After 20 years, when Maeve is 86 and Milo is 89, using the same assumptions, their equity will have shrunk to about $60,000. “They can’t be forced to sell and they can stay in their home as long as they want to,” Mr. MacKenzie says.
With no monthly payments on the reverse mortgage, and assuming the same level of spending, Maeve and Milo would have an annual cash flow surplus. This could serve as an emergency fund for household maintenance, car repairs, and medical and dental bills for themselves and their pets.
If they can afford to, the couple could tuck away some of this surplus in their TFSAs to partly offset the decline in their home equity.
“They might decide it would be worth using up some or all of their home equity so they could continue to enjoy, and even improve, their current lifestyle,” the planner says. The couple should get legal advice before taking out a reverse mortgage.
The people: Maeve, 66, and Milo, 69
The problem: Should they take out a reverse mortgage on their house?
The plan: Weigh the alternatives. They could sell and rent, cut their spending or take out a reverse mortgage. A reverse mortgage could be a relatively painless way to solve their cash flow problem.
The payoff: A way forward to fund the lifestyle they enjoy.
Monthly net income: $3,900
Assets: Residence $600,000; TFSA $500. Total: $600,500
Monthly outlays: Mortgage $1,005; property tax $395; electricity, heat $195; water, sewer, garbage $50; maintenance $155; garden $20; bird seed $35; home insurance $150; transportation $430; groceries $600; pet expenses $100; clothing $40; dining, drinks, entertainment $425; personal care $15; subscriptions $50; health care $175; cellphones $215; gifts, charity $25; credit cards $100; furnace payments $50; tax payable $50; other personal $20. Total: $4,300
Liabilities: Mortgage $191,000 at 4.7 per cent; credit card $2,000; income tax owing $1,400. Total: $194,400
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