Reverse Mortgage

Unlike a Home Equity Line of Credit (HELOC), which requires income verification and regular payments, a Reverse Mortgage (RM) allow senior homeowners (55+) to borrow up to 55% of the value of their home, with pretty much no questions asked.  The mortgage is secured by the equity in their home. If you take out a reverse mortgage, you can use the money to pay for anything you want (home repairs, bills, the good life, etc.).   You don’t even have to pay back the loan or interest until you sell your home or pass away. Utilizing this financial instrument can be one of the costliest mistakes a homeowner can make.

Perhaps the only benefit to the RM is that it allows one to cash-out at the peak of the market without moving since one can stay in the house.  Upon the sale of the house, the lender gets their money back.  However, if the selling price is less than the mortgage then the lender eats the loss, while the homeowner already received the cash, and any capital appreciation goes to the homeowner. 

Reverse Mortgages carry a higher lending rate than a regular home mortgage.  Today, the average is around 5.7% and will increase with interest rates. If the homeowner decides to not make any payments during the loan, each month the interest paid on the mortgage is automatically added to the outstanding debt.  This interest then becomes principal on the outstanding loan causing the interest expense to increase.  Once the mortgage is up to the initial value of the house, the mortgage outstanding never changes until the home is sold.

Most people using this type of mortgage simply want to stay in their home or are gambling that house prices will continue to rise. Your guess is as good as the next persons what house prices will be in 5 years time, let alone 20 years from now. From a financial perspective, given the market we experienced in the last 10 years, and that interest rates can only increase from current historical lows, it is more than likely prices for homes will be sticky on the downside for the foreseeable future.

Economically, chances are also that house prices will not be higher in 5 years time because every Catholic country has a shrinking population.  Within a decade it will become obvious.  In Canada, wages must skyrocket, and we will need an additional half-million people to immigrate to Canada every year to keep house prices up.  Today, the average household income is around $90,000.  With a 20% down payment, a buyer can safely afford a $360,000 home.  Yet, most homes are around $500,000.

Due to illness, the cost of maintaining a house, or the death of a partner, people must sell their home or borrow to keep it.  With a RM, and no change in prices, the seller ends up with no equity left and probably no savings to survive the rest of their lives.  The Canada Pension Plan monthly payments will rarely cover a small apartment rental.

The cons outweigh the pros when it comes to taking out a reverse mortgage. We feel it is better to sell the house and downsize, or sell and invest the equity elsewhere to earn income.  If money is needed for an emergency but you do not want to sell, borrow directly from your bank.  Most banks will be of help and it will be cheaper. Plus, one will end up with the equity in their home if forced in the end to sell.