Reverse mortgage

A reverse mortgage is a type of loan which allows homeowners, usually aged 55 or older, to access some home equity -- the portion of the home's value that is debt-free -- without having to sell the property. You pay back your loan when you move out of your home, sell it or the last borrower dies. This means you don’t need to make any payments on a reverse mortgage until the loan is due. Typical use of the funds are supplementing retirement income, or paying for unexpected costs during retirement.

Although the marketing can include statements like "Finance the kind of retirement you’ve always dreamed of", reverse mortgages are traditionally seen by financial advisors and many homeowners as a solution of last resort, since the interest rates are high, and the loan might consume most of the home equity over long time periods.

How it works

Normal mortgage versus reverse mortgage

With a normal mortgage, you take a loan from a bank to purchase real estate. You typically pay the loan back weekly or monthly over something like 25 years, and each payment is a blend of interest and principal. The early payments are largely interest and the final ones are mostly principal. Every year the loan balance decreases and at the end of the amortization period, the loan is entirely repaid. The interest rate is competitive, especially for people with good credit scores, because many banks offer normal mortgages and they compete for your business.

There are only two federally regulated banks offering reverse mortgages in Canada, and the interest rates are considerably higher. With a reverse mortgage, you can also get a lump sum immediately (although there are other options, see below). But instead of progressively paying it back, or at least paying some interest, many borrowers don’t make any regular payments until they reimburse the entire loan back, upon selling the house, moving out, or dying. So interest is progressively added to the loan amount, and the balance grows exponentially over time. It is the magic of compound interest at work, but against you. At the end, you pay back considerably more than what you have borrowed, potentially up to the full market value of the residence. While real estate prices tend to go up over time, this is not guaranteed, and it might only partly compensate for the ballooning loan balance.

Who offers them

Two financial institutions offer reverse mortgages in Canada. HomeEquity Bank offers the Canadian Home Income Plan (CHIP), which is available across Canada. You can get a reverse mortgage directly from HomeEquity Bank or through mortgage brokers. Equitable Bank offers a reverse mortgage in some major urban centres.

How much can you get?

Home equity is the current market value of a property, minus any outstanding mortgages. The proportion of home equity that can be tapped with a reverse mortgage depends primarily on the age of the homeowner(s) and can reach up to 55%, or even 59% at one provider. The home location and type (detached, semi-detached, etc.) are also factors. Your credit rating and current income are not factors, unlike for a home equity line of credit (HELOC).

A few minutes with the banks' online calculators reveals the following maximum percentages as a function of age (percentages may vary by location and other factors):

Age	Equitable	Chip
55	15%	18%
60	34%	22%
65	36%	26%
70	44%	31%
75	48%	39%
80	58%	45%
85	59%	53%
90	59%	56%

At the two federally regulated institutions that offer reverse mortgages, the minimum home appraisal value is $250,000 and the minimum loan is $25,000.

The loan can be set-up as a lump sum, a series of payments, or both. Those payments are tax-free and do not affect Old Age Security (OAS) or the Guaranteed Income Supplement (GIS), if applicable.

To maintain eligibility, the home must be a principal residence, property taxes must be paid and home insurance must remain in force.

When do you pay it back?

Unlike with a regular mortgage, there is no requirement to make regular payments, even for the interest component. Instead, the loan amount typically grows over time, and is repaid when the home is sold, the owners move out, the last borrower dies, or you default on the loan. The definition of "default" is one of terms that should be included in the reverse mortgage documentation.

You have the option to repay the principal and interest in full at any time. This will obviously save on interest costs. However, you may have to pay a fee to pay off your reverse mortgage early.

Since the interest rate is higher than on a traditional mortgage or HELOC, and no interest payments are typically made, the loan balance can grow quickly. Interest rates are in the 7-11% range as of March 2024. With a 7.2% rate, the loan approximately doubles every 10 years; with a rate of 10%, the loan doubles every 7.2 years (rule of 72). Here is what happens to a $100k reverse mortgage taken at age 65 with 10% interest (yearly compounding, for illustration) and no interest payments:

Age	Loan balance
65	$100,000
70	$161,051
75	$259,374
80	$417,725
85	$672,750
90	$1,083,471

Non-negative equity guarantee

Both federally regulated lenders guarantee that you will not have to reimburse more than the current market value of your home. This is known as the non-negative equity guarantee, is a form of risk transfer (insurance), and partly explains the high interest rates on reverse mortgages.

But lenders do not guarantee that the loan can't consume the entire home equity over a long period.

Costs

Besides the interest on the loan, costs associated with a reverse mortgage can include:

• home appraisal fees ($300-600)
• set-up fees and closing costs (more than $1000)
• legal fees ($500-1000)
• prepayment penalties if you pay off your reverse mortgage before it’s due

Pros and cons

The Financial Consumer Agency of Canada lists the following advantages and issues for reverse mortgages:

Pros

• you don't need to make any regular payments
• you may turn some of the value of your home into cash, without having to sell it
• you still own your home
• you may have options as to when and how you receive the money
• you don’t pay tax on the money you borrow
• this money doesn’t affect the OAS or GIS benefits you may be getting

Cons

• Interest rates are higher than most other types of financial products like a mortgage or a HELOC
• the equity you hold in your home may go down as you accumulate interest
• your estate may need to repay the reverse mortgage and interest within a set period of time when you die
• the time needed to settle an estate may be longer than the time allowed to repay a reverse mortgage
• there may be less money in your estate to leave to your children or other beneficiaries

Possible uses

Buffer asset

One of the most ‘accepted’ uses of tapping home equity retirement is as a buffer asset, to protect against shocks or unexpected/difficult to plan events. For example, you may eventually need funds to support home accessibility modifications and/or provide for long term care, typically in old age.

It is very difficult to budget for long term care because the future costs are unknown, and it may not even be needed (see the Long term care planning article). If the actual costs turn out to be significant, and other sources of funds are limited, accessing home equity through a reverse mortgage (or another type of loan, see alternatives below) could be a solution. One limitation is that at least one borrower must still live in the home which secures the loan. Since most people start to need LTC at rather advanced ages, the duration of the loan should be limited and interest costs should not balloon out of control. If the actual costs of long term care turn out to be small to non-existent, then the loan will not have to be taken at all, and the residence will form part of the estate.

Supplementing retirement income

Some seniors find themselves house-rich and cash-poor: their main asset is their property but that does not generate income for retirement. If they do not wish to downsize, one (costly) way to convert home equity into income is a loan like a HELOC or reverse mortgage. Doing so prevents (or lowers the potential of) using the home equity as a buffer asset.

A statistics Canada study from 2014 found that "only 2.11% of Canadian households reported planning to obtain a reverse mortgage as a source of income upon retirement".

Alternatives

If you are struggling to pay your property taxes (or other expenses of a similar amount) during retirement, some provinces offer tax deferment loans somewhat similar to reverse mortgages, but with interest rates generally more favorable than those mentioned above, and a "simple interest" (as opposed to compound interest) calculation. These loans must be repaid when the home is sold or no longer is your primary residence.

• BC
• Alberta

More general alternatives to reverse mortgages include:

• Spending less during retirement (don’t tap into home equity)
• Saving ahead of time for unexpected events (contingency fund)
• Selling the home to either downsize (buy a smaller home), move to a cheaper market, or rent a dwelling
• Getting another type of loan such as a HELOC, a regular mortgage or a personal loan (for small amounts)

See also

• Mortgage
• Line of credit

Further reading

• Financial Wisdom Forum topic: "Reverse Mortgage Application Process?"
• Financial Wisdom Forum topic: "Reverse Mortgage Loans - Downside??"
• Financial Wisdom Forum topic: "Reverse Mortgage to parent - how to setup"
• Financial Wisdom Forum topic: "The reverse side of reverse mortgages"

External links

• Financial Consumer Agency of Canada, Borrowing against home equity
• "CHIP Reverse Mortgage - Canada's Leading Reverse Mortgage Plan". HomeEquity Bank.
• "Reverse Mortgage". Equitable Bank.
• "Canadian Seniors Racked Up $408 Million More In Reverse Mortgage Debt This Year". Better Dwelling. December 29, 2020.
• Tamar Satov (September 23, 2022). "Has the time finally come for reverse mortgages?". The Globe and Mail.
• Clayton Jarvis (Nov 18, 2021). "How a reverse mortgage works in Canada, and why you should consider one". Financial Post and MoneyWide.
• "Reverse mortgages are booming amid Canada's turbulent rate environment". Canadian Mortgage Trends.
• "How Does a Reverse Mortgage Work in Canada + How to Avoid". The Smith Manoeuvre.
• Robb Engen (April 9, 2012). "Does A Reverse Mortgage Make Sense For Seniors?". boomer&echo.