What you need to know about reverse mortgages – MoneySense

How a reverse mortgage impacts your home equity

Reverse mortgages, second mortgages and home equity lines of credit (HELOCs) provide three different ways to create cash flow from a house you own. Of these three options, however, only the reverse mortgage does not require both income to qualify and at least minimal monthly repayment during the borrowing term. 

With a reverse mortgage, the existing home equity is used as security for the funds provided by the reverse mortgage. After the reverse mortgage is established, any future growth in the value of the house goes to the home owner. (If the home falls in value, the reverse mortgage lender takes the loss—the lender guarantees that the borrower will never owe more than fair market value of the home.)

Calculating the impact of the reverse mortgage on home equity thus becomes a function of estimating the term of the loan, the home’s value at the end of that term and the interest payable on the advanced funds. 

Part of a bigger picture

The growth in reverse mortgages is part of a bigger picture of debt and housing wealth among Canada’s aging population. Statistics Canada data shows that debt for the over-65 crowd has increased sharply in recent years, with the proportion of indebted seniors growing by more than 50% from 1999 to 2016. 

Over this period, the average increase in seniors’ debt was $50,000, of which fully 67% was mortgage debt. At the same time, however, the average increase in seniors’ assets was just over $500,000, of which 51.7% is attributable to real estate assets—meaning that seniors’ increased (mortgage) debt is, on average, moderated by their increased (real estate) assets.  

HomeEquity Bank says their average customer is a 72-year-old who borrows $170,000 to pay down their debt and supplement their income. Reverse-mortgage funds could also be used to fund renovations that let you stay in your house longer, to help your child or grandchild with an “early inheritance,” to provide “bridge” financing if you wait to take Canada Pension Plan (CPP) or Old Age Security (OAS) benefits, or to pay for long-term care or long-term care insurance. And because the funds aren’t taxable when you get them, there’s no impact on government benefits that can be clawed back based on your taxable income, such as OAS and the Guaranteed Income Supplement (GIS). 

The future of reverse mortgages

The conventional wisdom on how to treat housing wealth in retirement has been to preserve it as a last-resort option, with reverse-mortgage lenders thus viewed as “lenders of last resort.” If housing wealth is not needed to help fund retirement, this view goes, the home can be left as part of the legacy for the next generation. As a result, it’s easy to find reverse-mortgage naysayers: former Minister of National Revenue Garth Turner famously quipped that reverse mortgages are “an ideal strategy, if you hate your children.”

The criticisms of reverse mortgages tend to focus on the rates, which are higher than comparable five-year mortgage rates and several percentage points higher than HELOC rates. Another focus of criticism is the overall indebtedness of seniors who may have few, if any, other options. This lack of options, however, is what puts reverse mortgages on the table in the first place: With lowered incomes in retirement, mortgages and HELOCs may be unavailable to many Canadians.