Pros and Cons of a Reverse Mortgage

With so many baby boomers already retired, the massive generation born between 1946 and 1964 will be reconsidering their mortgage plan.


They will be downsizing to a smaller residence, or stay in the family home and possibly get a reverse mortgage. There are very definite pros and cons to the decision.


A Reverse Mortgage provides a way for homeowners to access some of the value of their home, while still retaining ownership. To be eligible for a reverse mortgage, you must own a primary residence and be 55 years or older.

It would appear that securing a reverse mortgage would be a very positive decision. The marketing being used to promote the choice is undeniably convincing: You can stay in your home and remain independent. You will enjoy financial freedom in your retirement. Why not renovate your house, travel or give money to your kids? Your home will continue to appreciate in value and offset the interest costs and loss of equity. Right?


Advantages:

  • Payments from a reverse mortgage are tax-free income.

  • income-tested benefits such as Old Age Security or Guaranteed Income Supplement will not be affected.

  • Won't have to repay it until you sell your home or when you or your surviving partner pass away.

  • You eliminate monthly payments.

  • You can repay the loan at any time.

  • The amount you owe can never exceed the value of your property.

  • You and your beneficiaries aren't responsible for any shortfall if interest rates increase and housing values drop.

  • Depending on the provider, funds can be received as a lump sum, regular payments or a combination of lump sum and regular payments.

  • Interest paid on the reverse mortgage is tax deductible if the proceeds are used to earn investment income (interest or dividends).


Disadvantages:

  • Your home may continue to appreciate in value and offset some of the interest costs and loss of equity. However, interest will rapidly accumulate on the amount you borrow.

  • Providers market the benefit of using a reverse mortgage to bolster your savings and shift wealth from your home to your investments. This form of leverage adds serious risk.

  • Because of the start-up fees and higher rates of interest, reverse mortgages are more costly than conventional lines of credit or mortgages. If you choose to make early payment of all or a portion of the amount borrowed, you could be subject to prepayment penalties.

  • Suffice it to say, borrowing against your home will deplete the amount being passed down to your beneficiaries.

  • Only two companies in Canada offer reverse mortgages: Canadian Home Income Plan (CHIP) and Seniors Money Canada. Many mortgage brokers or Accredited Mortgage Professionals (AMP) will provide information and advice regarding reverse mortgage products. Reverse mortgage providers partner with banks, credit unions, mortgage brokers, financial and investment advisers and other financial professionals who are compensated for providing client referrals.

  • Start-up fees for reverse mortgages can be significant. Start-up fees typically include an application fee, home appraisal fee, and costs for independent legal advice. Fees are deducted from the principle received.You can expect to pay $1,800 to $2,300 for legal and administration fees. $300 to $400 for an appraisal and an additional $300 to $500 for independent legal advice if your lender requires it.

  • The amount you are able to borrow through a reverse mortgage varies dramatically based on location, type of housing, your age and gender, and the amount of your current debt.


Eating the Equity

Unlike a standard mortgage, reverse mortgages are a debt that continues to grow until it consumes the equity in your home. The balance (principle borrowed plus accumulated interest), won't need to be repaid until you sell or pass away. However, the debt can reach a level that the equity remaining will not be enough for you to consider alternative housing. It is imperative that you seek independent legal advice, to ensure you are entering into the agreement freely, without pressure, and that you understand the contract and potential risks.

All costs, advantages, and disadvantages need to be carefully contemplated before entering into a Reverse Mortgage agreement. The amount you can borrow is determined by your age. The younger you are, the less you can borrow. 55 to 60 year old's can only borrow up to 15 per cent of the value of their home, while someone in their 80s can borrow up to 55 per cent.

Valuable Lessons

1) Borrowers need to be aware of the dangers of compound interest. It is great when saving, but extremely costly when borrowing.

2) People who take out reverse mortgages usually have cash flow problems. It's very unlikely they will be able to repay the mortgage early.

3) If you are able to pay down the loan, you could be subject to a prepayment penalty of up to five per cent. This penalty reduces over time and usually disappears after five years.


4) If a married homeowner dies, the contract remains in force until the other spouse dies. If the homeowners end up moving to a care home, the prepayment penalty is reduced by 50 per cent. You can't keep the home, maintain the reverse mortgage, and live in a care home at the same time.


Make an Educated Decision


You need to weigh the pros and cons of a reverse mortgage. You may prefer a conventional mortgage or to sell your home. Make an educated decision on what will be best for you and your family.

If you deal with a broker who offers both conventional and reverse mortgages, you are more likely to get an unbiased opinion.

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