Is a reverse mortgage worth the risk?

A reverse mortgage allows home owners to obtain cash based on the value of their home and the equity accumulated. The homeowner can choose to receive a lump sum amount, or can opt to receive a series of payments which will provide a regular income stream, or some combination of the two. No repayment is required until the death of the homeowner, or until he or she leaves or sells the home.

A reverse mortgage can sound like the perfect solution to a cash-strapped retiree. The ability to ease cash flow worries while remaining in one’s own home with no requirement to make any payments at all can sound like the best of all possible worlds. A reverse mortgage can make sense for retirees who are house rich but cash-flow poor.

But, as with all financial strategies, it’s necessary to understand both the benefits and the potential costs and risks of getting a reverse mortgage.

The potential downsides of a reverse mortgage start with the costs of obtaining one. Setting up a reverse mortgage involves a number of costs for the homeowner, including property appraisal, a set-up fee, and interest rates which are higher than traditional mortgages. There will also be closing costs, and the required independent legal advice.

Once the reverse mortgage is taken out, interest will accumulate from the time the funds are first advanced. Total interest can add up very quickly and reach significant amounts by the time the debt is eventually to be repaid, usually out of the proceeds from the sale of the house.

In order to obtain a reverse mortgage, the homeowner must be at least 55 years of age, and the amount obtained is limited to 55% of the current value of the home. Where there is already a mortgage or other form of loan secured by the home (as is increasingly the case for retirees), the reverse mortgage lender will require those first be paid off with the funds received from the reverse mortgage.

The major benefit of a reverse mortgage for many retirees is that they are not required to make payments while living in the home. However, a prepayment penalty is levied if the homeowner moves or sells the house within a certain time frame.

Many retirees who obtain a reverse mortgage do so with the thought that the debt will not need to be repaid until after their death, when the house will be sold. But, consider the possibility that the homeowner will need to move at some point. For example, if the retiree moves to an assisted living facility and is counting on equity to pay for it, the reverse mortgage will reduce the funds available.

For those who are considering whether a reverse mortgage is the right solution for them in retirement, Canada’s Financial Consumer Agency suggests getting answers from prospective lenders to the following questions:

• What are all the fees?
• Are there any penalties if you sell your home within a certain period of time?
• If you move or die, how much time will you or your estate have to pay off the loan’s balance?
• When you die, what happens if it takes your estate longer than the stated time period to fully repay the loan?
• What happens if the amount of the loan ends up being higher than your home’s value when it is time to pay the loan back?

More information on reverse mortgages in general can be found on the FCAC website at https://www.canada.ca/en/financial-consumer-agency/services/mortgages/reverse-mortgages.html.

The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.