Reverse Mortgages: Buyer Beware!
Giving your home’s equity to a creditor should be a last resort
By Dave Gracey
The financial industry is always on the hunt for new ways to grow debt. It is no accident that average household debt in Canada is now 165 per cent of disposable (after tax) income. While debt may be a burden to the borrower, the interest is profit to the creditor. If the interest rate is high, and the risk of default low or non-existent, this is a great deal for the lender.
That is why there are so many ads for reverse mortgages on TV- those healthy, smiling seniors talking about taking a cruise, or helping their children with ‘easy money’ from a reverse mortgage. And you continue to own the house until it is sold!
A regular ‘forward’ mortgage lends the borrower a large part of the money to purchase a house. The homeowner then repays the loan, plus interest, over a period of years. As payments reduce the amount of principal owing, less interest accrues and the equity grows. A reverse mortgage inverts this process. The borrower must already own the house and it must be free of all liens. In reality, a reverse mortgage is simply a loan that uses the house as collateral. The interest and principal will come out of the equity you have in the house. You can stay in the house until sale or death but the longer you stay, the less equity you have in your home.
The amount of the loan will vary with your (and your spouse’s) age, and the assessed value of the property. You have to be 65 to be eligible for a 40 per cent reverse mortgage. That means that a house assessed at $500,000 would support a loan of $200,000. One company I contacted quoted a rate of 4.9 percent. At that rate, the interest payable over 10 years would be $122,500 if compounded annually. It would be more if compounded semi-annually or weekly. If you lived long enough, the equity would be gone and you could continue to live in the house. But the company is betting that won’t happen, or that the house value will appreciate over that time. In addition, you will have to pay a hefty fee to have your property evaluated and to set up the deal.
Of course you are allowed to pay the interest every year to maintain your equity. But if that were your intent, you would be better off with a regular loan or line of credit which would carry an interest rate of about 3.5 per cent, using your house as collateral.
The market for reverse mortgages is clearly growing. To date, about 12 per cent of seniors have taken the plunge because their house is their only asset and they have a need for money. If you are considering getting a reverse mortgage, think it over carefully. This may not be the best option.