The largest age demographic in Canada consists of people born between 1946 and 1965, known as the Baby Boomers.  Last year,the first Baby Boomers began entering senior citizenship (the age of 65). Currently, senior citizens make up 15 per cent of the population numbering almost five million strong. As Baby Boomers continue to age, their numbers will balloon the senior citizen population in Canada. According to demographic forecasts, 23 per cent of the population will be 65 or older in 20 years’ time (an increase of 8 per cent).
“The proportion of seniors will grow more rapidly in the coming years as the first generation of baby boomers are now reaching the age of 65” – StatsCan
Which brings us to a crucial question: With so many Canadians poised to hit retirement, how many are financially prepared for the years ahead? For some individuals, prudent pension planning and smart investing has them well equipped for the future. Sadly, this will not be the reality for many others who will need to find alternate income sources. That’s where reverse mortgages can help.
About reverse mortgages
In a conventional mortgage, a person borrows money from the bank to become a homeowner and then gradually pays back the loan. With a reverse mortgage, the lender advances the homeowner a cash amount in exchange for a portion of the equity they have in their home. So, with a regular mortgage, cash flows from the homeowner to the lender, and with a reverse mortgage, cash flows from the lender back to the homeowner. Therefore, a reverse mortgage’s principal goes up over time rather than down as is the case with a conventional mortgage. In either situation, the mortgage is secured by home equity which is defined as:
Value of Home – Unpaid mortgage balance = Home equity
In essence, a reverse mortgage is backwards financing, where the mortgage pays the homeowner cash. Sometimes referred to as a home equity conversion mortgage, a reverse mortgage is mostly issued by the Canadian Home Income Plan Corporation (CHIP).  According to James Laird of True North Mortgage, “In a reverse mortgage, you are slowly selling your house back to the bank. It is the exact opposite of a regular mortgage. Instead of paying the bank, the bank pays you. In a regular mortgage, you pay cash to the lender for ownership of a home, but in a reverse mortgage, the lender pays you cash for ownership.”
In a reverse mortgage, the homeowner does not make mortgage payments, but instead the interest on their reverse mortgage accumulates while their equity decreases over time. If the home is sold, the borrower is responsible for repaying the loan and the total interest that has accumulated.
Also, although the homeowner is giving up equity in their home, they still maintain the title to their home and are responsible for the property including the payment of taxes.
Who would need a reverse mortgage?
A reverse mortgage allows elder homeowners to obtain cash, without selling their largest asset – their home. It can be used as a financing plan for retirees who find themselves ‘house rich’ but ‘cash poor.’ The borrower can choose how they want to receive the payment from the reverse mortgage. There are three possible options:
- Receive a lump sum payment (cash all at once)
- Scheduled advances to simulate regular income
- A combination of both
To be eligible, homeowners must be at least 55 years old.
What are the advantages of a reverse mortgage?
- A reverse mortgage is different from a typical loan because it does not require regular payments to be made on the loan
- The ability to ‘withdraw’ cash from the value of your home without having to sell it.
- The payment from the reverse mortgage is entirely TAX-FREE
- The money from the mortgage does not reduce your eligibility for Old-Age Security (OAS) or Guaranteed Income Supplement (GIS) benefits
What are the disadvantages of a reverse mortgage?
- Reverse mortgages have higher interest rates compared to typical mortgage rates or home equity lines of credit
- The various costs associated with the process include:
- Home appraisal fee: $175 to $400
- Legal fees: $300 to $600
- Closing and administrative costs: $795 to $1,495 (depending on the reverse mortgage term)*
- Upon death, your estate is responsible for the costs, which could leave very little for your beneficiaries
- There is risk that the time required to settle an estate can exceed the time required to repay the reverse mortgage
- Your equity in your home decreases over time while interest on the reverse mortgage accumulates
*Note that the closing costs and administrative fees will be deducted from the funds, i.e. you will not have to pay “out of your pocket”
According to statistics provided by HomEquity Bank, the average applicant is approximately 72 years old and borrows an average of 36 per cent of the equity in their home. After the home is sold and the reverse mortgage paid off, the average amount of equity left in the home is close to 50 per cent.
Qualifying for a reverse mortgage
In Canada, qualifying for a reverse mortgage is different than qualifying for a conventional mortgage. CHIP will likely require homeowners to pay off debts first before beginning the loan process. Also, income is not considered during the qualification process as it is with a typical mortgage, as the reverse mortgage IS the income. Homeowners considering this type of loan should meet with financial advisors and legal counsel.
Steps to acquire a reverse mortgage
- Request an estimate online or call 1 866 522 2447 to speak to a CHIP Home Income Plan Representative to set up a meeting.
- If a reverse mortgage is right for you, you will have to complete an application and arrange for an independent appraisal of your home.
- Once the appraisal has been received, a meeting at your bank will be arranged to confirm the exact amount of money you have qualified for.
Each case is determined individually based on age, gender, the appraised value of the home, the type of home, and the geographical location. Here is an example on the amount of cash that could be advanced based on CHIP’s eligibility tool:
A 65-year old male living with a 65-year old female in a $350,000 home in Markham, Ontario and $50,000 debt, are eligible for a cash advance of $65,995 to $73,485 which could be received in full lump sum or distributed on a monthly basis
There are other options for elder homeowners to source funding other than a reverse mortgage. A mortgage refinance strategy is also a viable option. “Elderly homeowners can also consider setting up a Home Equity line of Credit, which allows you to withdraw funds on a regular basis, up until the limit of the Home Equity Line of Credit is reached. The advantage of this strategy is the interest rate is lower, but the disadvantages are that they are harder to qualify for and the payment is not fixed, so stricter budgeting is required,” said Mr. Laird.
There is also the alternative option for homeowners to sell their home and downsize to a less expensive home, and pocket the cash to pay for living expenses.
Seniors should speak with a mortgage broker in Canada and a financial advisor about which strategy is most appropriate for their unique situation because a decision should be made only after careful deliberation.