Tuesday, September 15, 2009

Reverse mortgages - advantages and disadvantages

From my CBC radio national column, September 10, 2009:

You’ve probably seen them…those commercials telling seniors that thanks to their paid-off home, they’re sitting on a gold mine. Why not take a vacation, put the grand kids through school or help your kids with a down payment on a home of their own. The products these ads are promoting are called reverse mortgages, and here you'll find the straight goods on them.

So what exactly is a reverse mortgage?

  • They’re an option for homeowners over the age of 60 years old.
  • A senior is able to tap into the equity in the home up to 40% of its value.
  • The ads are targeted at people who have already paid off their homes (although you can still qualify if you have an existing mortgage.)
  • People taking out a reverse mortgage don’t make any payments unless they sell or move. Repayment would also be required in case of death. or pass away.
  • The amount a person receives can be paid in a lump sum or even monthly or annual instalments.
  • The company that most people know is CHIP, or Canadian Home Income Plan. But there’s another firm that offers reverse mortgages, called Seniors Money.

I must stress the fourth point that yes, you don't make a payment during the life of the reverse mortgage (unless you sell, move or pass away) and thus interest is compounding during that time period. This is the lure of the reverse mortgage but it needs to be fully comprehended by the senior that the longer the reverse mortgage is in place, the more it's depleting equity in your home.

Why would someone consider this strategy?

This might have appeal to cash-strapped retirees. If someone wants to stay in their home and simply doesn’t have the monthly income to manage the bills, wants to renovate their home, perhaps needs money for home care assistance, it could be an option worth considering.

What the experts have to say about reverse mortgages

I had last week with PJ Wade. She’s the author of Reverse Mortgages: Best Friend, Worst Enemy...Your Choice!. As an expert on the subject, she stressed that education is key. She points out that many seniors don’t realize that, while a reverse option might end up being the right choice for them, there are other options they should know to consider first. She suggested that seniors start by looking five years into the future.

So five years before they think they might need to tap into the value of their home, seniors should gather all available information on the options to them—everything from reverse mortgages to home equity loans.

This way if someone tries to sell them on a product like a reverse mortgage down the road or a desperate need comes along, they’ll be well prepared. We generally don’t make good, informed decisions when we’re stressed or under pressure.

The other thing to think about is inheritance. Maybe you want the value of the home to go to your children down the road or maybe that’s not a priority. But it should be thought about in terms of your advance or estate planning.

Consider that the sales pitch for these products is often "well, in theory your home will increase in value as the interest is accrued, so you could actually not dip into your equity at all." Sure, that's possible, but we all know that "in theory" and "in reality" are two very different things. We've also seen housing prices slashed in many provinces.

What do some other financial professionals have to say about reverse mortgages?

The big criticism of reverse mortgages are the fees involved.

Besides PJ Wade, I also spoke with Keith Costello, President of the Canadian Institute of Financial Planners. He cautions the high fees that exist with reverse mortgages including closing, appraisal, legal and administrative costs. These are all upfront costs. So you have to be aware of the fact that these fees will be taken right off the top of the amount they give you.

I called CHIP myself and asked about fees.

First there’s a fee of $1,495, that includes their legal and administration costs. Anyone arranging a reverse mortgage will also need to pay a lawyer – that cost of that typically ranges from $300-600. And lastly, there's an appraisal, which is also out of pocket - they range of $175-400.

Also, the interest rate on reverse mortgages tends to be higher than what you would negotiate for a traditional mortgage with your banker (see rates below.)

Finally as with any loan, which is really what a reverse mortgage is, the responsible use of the money is really important. What if all the funds are used on vacations and other spending and the senior out lives that money?

As a precaution, Mr. Costello, suggests that although you might be able to get up to 40% of the value of your home, ONLY take what you need.

What other options exist?

There are lots of other options that might exist including a line of credit or traditional mortgage with your bank if you have the cash flow to cover the payments.

Or you could consult a CFP might be able to help you restructure your investments to free up cash flow.

And when it comes to needing funds to renovate, a reverse mortgage might make sense if the money is being used to increase the overall value of the home and your enjoyment of living in it. But seniors should also remember that there might be some government grants out there that could pay or help them pay for things like windows and furnaces for example.

Would I recommend my mother take out a reverse mortgage?

As with any product, there’s no good or bad out there, it’s what’s good or bad for one’s situation.

If she had no other option, desperately needed the money and no other sources existed and she was adamant about staying in her home, then maybe yes. But, having said that, I would advise her that it should be a last resort option, not a quick fix as the commercials portray due to the high costs up front and compounding interest over time.


More CHIP facts:
-they do have approx 7,000 rev. mortgages on the books
- totalling approx $833 million dollars
-their rates as of September 9 were more than RBCs for example
-As of Sept 10th, 2009 - CHIPs rates - 5.3 for variable, 6mth is 6.25, 1 year is 5.95, 3 year is 6.95 and 5 year 7.50

RBC's rates for example (Sept 10th, 2009 posted rates)
6 Month 4.55% 4.05%
1 Year 3.70% 3.20%
2 Year 3.85% Call for details
3 Year 4.35% Call for details
4 Year 4.94% 3.89%
5 Year 5.49% 4.19%


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