If you’re over 55 and still live in the home you own, a reverse mortgage can help to increase your cash flow
In many cases, the typical revenue sources—OAS, CPP, savings and pensions—fall short, says personal finance trainer, David Trahair, CPA. “It’s largely because some people didn’t save enough and have been spending more than they have been making.”
One option Canadians have been turning to recently is a reverse mortgage. According to the Office of the Superintendent of Financial Institutions, the outstanding balance of reverse mortgage debt reached $4.42 billion in October 2020, a 12.25 per cent increase over the same month the previous year.
The premise is a simple one: if they qualify, a homeowner over the age of 55 can turn up to 55 per cent of the value of their home into cash in the form of a lump-sum payment or annuity. But before you make the decision to take out a reverse mortgage for yourself or a loved one, here are some other things to consider:
1. WEIGH YOUR BORROWING OPTIONS
While many turn to credit cards for financial help, Trahair cautions against it due to the high interest rates. A home equity line of credit is a better option, he says. “It’s best to apply for a line of credit while you are still working because the bank can more easily verify your income and it is usually higher than during retirement.”
If you are not eligible for a line of credit, perhaps due to a poor credit rating, that’s where a reverse mortgage may be a viable option. While the interest rates in the five- to seven-per-cent range are higher than a home equity loan or mortgage at under two per cent, they are much lower than credit card debt, explains Trahair.
“The bottom line is a reverse mortgage is a last resort for people that don’t have the credit rating to secure other loans. If you can’t get a home equity line of credit, it might make sense.”
2. EVALUATE YOUR SITUATION
A reverse mortgage can help a person living on a limited income to augment their cash flow so they can continue to live comfortably in their homes. Or they may need to pay for in-home supports that cost more than their monthly income. For the most part, people tend to use a reverse mortgage for practical things, says CPA Steve Ranson, president and CEO of HomeEquity Bank. “They’re not used to book an around the world cruise.”
Sergio Simone and his sister are in the process of finalizing a reverse mortgage for their elderly parents in Toronto. “Our parents are getting 24-hour care at home. We want them to be able to stay at home, but the care is very expensive. They have some investments and pension money, but any unexpected costs will exceed their income,” he explains. “A reverse mortgage works for our situation.”
3. UNDERSTAND THE OBLIGATIONS
Keep in mind that there are a number of associated fees that go along with a reverse mortgage. Appraisal fees can run from $300 to $600, independent legal advice from $300 to $700 and closing and administrative costs around $1,795.
On the bright side, you won’t lose your home or have to make payments. “It’s a loan that is paid back when the house is sold,” says Ranson. “The interest is a bit higher than a conventional loan, but you never have to requalify or renegotiate terms. Reverse mortgages are the only way to access equity without having to make payments.”
Borrowers also have the flexibility to choose how they access their funds. You can take all the money up front as a single payment and spend it on a single need such as consolidating debt or financing renovations, spend a portion and save the rest for a later date or set up regular monthly instalments.
Simone says that the funds from their parent’s reverse mortgage will be set aside until they need to increase their parent’s household income. “Everybody has individual needs,” he says. “Somebody else might do it for another reason.”
Also, since the cash from a reverse mortgage—whether provided in a lump sum or monthly— is an additional loan, it is not taxed. (You are deferring tax on gains that will not need to be paid until the house is sold.) “Because it’s not income, it doesn’t impact government entitlements, such as your Old Age Security,” says Ranson.
“If you’re retired, and don’t want to draw down on the investments you have left or pay tax on the sale of your remaining investments, a reverse mortgage might be an option to consider,” says CPA Michael Massoud, principal, financial literacy at CPA Canada.
“That is, unless you can find a cheaper method of borrowing,” stresses Trahair.
4. DO YOUR RESEARCH
Massoud stresses the importance of taking the time to understand if a reverse mortgage is the best option. “It really depends on the circumstances,” he says.
For example, it may not be the best tool if you don’t want to erode the value of your estate or if you anticipate having to move at some point. Also be aware that interest rates are higher than a traditional mortgage, so it’s best to take the time to compare lending costs versus a conventional mortgage or home equity line of credit, including up front fees.
Some final words of caution: Be sure to get some advice from a finance professional, as well as independent legal advice. It’s important to explore all of your options and make sure you understand how the transaction works, as well as your obligations.
“Also, involve family members in the process so everybody has a good idea of what’s going on,” says Ranson.
“There can be issues with next of kin,” says Trahair. “Some aging couples running into cash flow problems don’t want to tell their children about taking on a reverse mortgage, which can lead to an unpleasant surprise when they’re sorting out the estate. It’s important that everyone knows what is going on.”
BUYERS BEWARE
If you’re in the market for a home, watch out for these three types of real estate fraud and learn about financial considerations for first-time homebuyers. Plus, find out why you should never lie on your mortgage application.
Author: Denise Deveau
Source : CPA Canada
