The reverse mortgage quandary
From Monday’s Globe and Mail
On the surface, reverse mortgages seem like the ideal solution for cash-strapped seniors. You can tap the equity in your home, you don’t have to make any interest or principal payments, and the mortgage only comes due when you die, sell your house or move out permanently.
As more boomers hit retirement age, reverse mortgages are growing in popularity. HomEquity Bank, Canada’s only national provider of reverse mortgages to people aged 60 and over, expects to hit $1-billion in loans outstanding during the fourth quarter.
More related to this story
“The beauty of this is it gives people the financial flexibility and the freedom to do things that have to be done,” said Bob Lauzon of Cornwall, Ont., who recently arranged a $30,000 reverse mortgage for his 87-year-old mother to pay for a new roof and other home improvements.
But while reverse mortgages may be a good fit for some seniors, the products aren’t for everyone. Some financial planners advise clients to avoid reverse mortgages altogether and explore cheaper options. Knowing how reverse mortgages work, how much they cost and the pitfalls to avoid is critical for anyone considering this option.
What’s a reverse mortgage?
With a conventional mortgage, you borrow a certain amount and gradually pay it back. Not so with a reverse mortgage. The lender advances you a lump sum (or provides the money in stages) and you make no monthly payments. As a result, the accrued interest is added to the loan balance, and the mortgage steadily grows.
High rates hurt
Interest rates on reverse mortgages are higher than those on traditional mortgages or credit lines. Currently, HomEquity Bank, which operates the CHIP Home Income Plan, charges 5.9 per cent on a fixed, five-year mortgage. That compares with rates as low as 3.5 per cent for conventional five-year mortgages.
Because the interest compounds, the mortgage can quickly balloon. For instance, if you borrow $150,000 at 5.9 per cent, after 10 years you’ll owe $268,298 (assuming semi-annual compounding). When you die or sell your home, that money will have to be repaid, leaving less cash for your estate or to pay your bills.
“It’s all negative amortization.