What is a Reverse Mortgage?

A reverse mortgage enables homeowners aged 55 and above to tap into the equity of their home without needing to sell it. Unlike conventional mortgages, it requires no monthly payments, and the loan is settled when the homeowner sells the property, moves out, or passes away. This financial tool is often utilized by retirees seeking additional income in their later years. However, while reverse mortgages offer necessary funds, they come with considerable costs and risks.

How Reverse Mortgages Work

A reverse mortgage essentially transforms part of your home’s equity into loan proceeds, which are offered in different forms, such as lump sums, monthly payments, or a line of credit. These funds are not taxable, and repayment of the loan isn't required until the home is sold or vacated. The loan amount is determined by factors such as the home's value, the homeowner's age, and current interest rates. The most popular reverse mortgage product in Canada is the Home Equity Bank's "HELOC for Seniors," but other options exist depending on the lender.

Types of Reverse Mortgages

In Canada, reverse mortgage options are more limited compared to the United States and are mainly provided by two banks:

HomeEquity Bank (CHIP Reverse Mortgage)
Equitable Bank (Reverse Mortgage)

The loans offered by these two banks generally include these forms:

Lump Sum
Regular payments (such as monthly)
On-demand drawdown (similar to a line of credit)

Reverse Mortgage Pros and Cons

Reverse mortgages have both benefits and drawbacks that should be evaluated before obtaining such a loan.

Pros:

No Monthly Payments: Unlike traditional mortgages, you don't have to make monthly payments. The loan is repaid when the homeowner sells the home, moves into care, or passes away.
Access to Cash: It allows seniors to utilize their home equity without needing to sell their property, providing a dependable income source.
Non-Taxable Income: The money from a reverse mortgage is not seen as taxable income, potentially making it a tax-efficient option for retirees.
Flexibility in Payment Options: Homeowners can select from a lump sum, monthly payments, or a line of credit, offering them some flexibility to meet their financial requirements.

Cons:

High Fees: Reverse mortgages may involve steep fees and interest rates compared to other loan types.
Decreasing Equity: As the loan balance grows over time due to accruing interest, the equity in your home diminishes, possibly reducing the inheritance for your heirs.
Impact on Inheritance: If the loan balance surpasses the home's value at repayment, heirs might inherit nothing, as the property is sold to clear the debt.
Eligibility Requirements: Not everyone qualifies for a reverse mortgage. The homeowner must be at least 55 years old, and the home must satisfy certain criteria.

Reverse Mortgage Fees

The fees associated with reverse mortgages can vary, but they typically include:

Origination Fees: These are fees the lender charges for processing your loan application and setting up the loan. Depending on the loan size and lender, they can vary from a few hundred dollars to several thousand dollars.
Interest Rates: Interest rates on reverse mortgages are often higher than those on conventional mortgages since the lender doesn't require regular payments, and the loan balance grows over time.
Insurance Fees: Some reverse mortgages mandate insurance, which adds to the loan's cost, typically protecting the lender if the home's value is lower than the loan amount upon repayment.
Closing Costs: Similar to traditional mortgages, reverse mortgages also involve closing costs like appraisal fees, legal fees, and title insurance.

These fees must be accounted for when determining whether a reverse mortgage is the right fit for you.

How Much Money Do You Get from a Reverse Mortgage?

The amount you can borrow through a reverse mortgage depends on several factors:

Home Value: The higher your home's value, the more you can potentially borrow.
Age of the Homeowner: The older you are, the more you might be able to borrow since the lender expects the loan to be repaid sooner.
Current Interest Rates: Higher interest rates reduce the borrowing amount as they impact the loan balance over time.
Equity in the Home: The more equity you have, the more funds you may access.

Typically, homeowners can borrow between 30% to 55% of their home’s appraised value, depending on these factors.

Common Problems with Reverse Mortgages

While reverse mortgages can be advantageous, they also come with serious issues homeowners should be mindful of:

Increased Debt Over Time: Without monthly payments, the loan balance increases over time due to accumulating interest, depleting the equity in your home.
Potential Impact on Government Benefits: Money from a reverse mortgage may affect eligibility for certain government benefits, like the Guaranteed Income Supplement (GIS) in Canada. It's crucial to consult a financial advisor to understand how a reverse mortgage could impact your other income sources.
Risk of Losing the Home: Non-compliance with loan terms (such as failing to pay property taxes or insurance) can result in foreclosure by the lender.

Reverse Mortgage Alternatives

Before opting for a reverse mortgage, you might consider alternatives such as:

Home Equity Line of Credit (HELOC): If you have sufficient income and are below the age threshold for a reverse mortgage, a HELOC might be a better option, offering lower interest rates and more flexible repayment terms.
Selling Your Home: If living in your home is no longer desirable, selling and downsizing could provide the cash you need without reverse mortgage complications.
Government Benefits and Grants: Seniors might qualify for additional government programs or grants to help with financial needs, such as the Canada Pension Plan or provincial senior assistance programs.

The Truth About Reverse Mortgages: What You Need to Know Before You Borrow