In my practice I see a lot of older Canadians finding themselves facing debt problems they never expected to face in their senior years. In fact, debt among seniors is a growing trend, something to be concerned about. So when I first heard of reverse mortgages (quite a few years ago) my reaction wasn’t favourable. Now that I have taken the time to look into them in greater detail I am definitely convinced that they are not a good idea…
How Does A Reverse Mortgage Work?
In case you don’t understand how a reverse mortgage works, here’s a quick explanation:
If you own your home a reverse mortgage allows you to borrow up to 50% of the home’s value with no repayment until you sell your home. This effectively gives you access to a lumpsum of money that you can use as you see fit. It is tax free because you’re accessing the equity you’ve built up in your home (think of it as cashing out a really big savings bond).
That sounds like a great deal, but there is a cost and it is quite high.
- Interest will accrue on the amount you borrow.
- Since you aren’t making any payments, you’ll also be paying interest on the interest.
- Interest rates charged on reverse mortgages are higher than the interest rates charged on a regular mortgage.
- Interest rates on the product are not fixed so there is significant risk, given that we are at historically low interest rates right now, that the rate you will be charged 5 to 10 years down the road will be quite significant.
The effect of this compounding high interest is that you are using up some portion of the rest of the equity in your home. If you stay in your home long enough, there may be little or no equity left when you finally sell.
Better Alternative Borrowing Options
Reverse mortgages are sold to seniors needing cash flow. Most use the money to cover living expenses but I have had people as me if they should use the money to consolidate other debts.
If you need a large sum of money, whether to consolidate credit card debt or to be able to afford to stay in your current home or even travel, then perhaps you should consider these alternatives:
- A secured line of credit on your home – this will allow you to access the equity in your home like the reverse mortgage, but it will require some form of repayment. At a minimum, you must pay the interest charges each month. By doing so, the interest charges don’t compound (you don’t end up paying interest on your interest) and it will save you thousands of dollars in interest charges. Unfortunately, you have to make a payment.
- Take out a traditional mortgage on your home – this will provide you with access to your equity at the lowest possible interest rate, but the monthly payment will be larger than the payment required with a secured line of credit (option #1). You can also gain the advantage of a fixed interest rate for the term of the loan. This may be the best bet if you plan to sell your home within say 5 to 10 years. You can choose a long amortization period to lower your monthly payment, but you will still need to ensure you can fit the repayment into your budget. Borrowing more than you need, and investing the balance to use for repayment until you do sell is one way to manage this but it will take some financial savvy to make all the numbers work.
- Sell your home – use this as an opportunity to downsize. By selling your home you won’t incur any interest charges, the money you receive will be tax free and you can use the excess funds to either invest, or perhaps buy a new home that may be easier to maintain and more appropriate to your senior years.
None of these options is identical to the reverse mortgage, but they all are significantly less expensive. Whatever you choose to do, talk to a financial advisor first. As long as you do the calculation to see just how much a reverse mortgage will cost you if you stay in your home 5, 10 or more years, then you are making an informed decision regarding the increased cost. It is after all your home and your money – you need to decide what makes the most sense for you.