The house is a very representative asset on the balance sheet of several households. So, before using a financial product that can affect it, it is better to know its different characteristics.
WHAT IS THE REVERSE MORTGAGE?
A reverse mortgage is a loan secured by the equity in your home. It provides between 10 % and 40 % of the appraised value of the principal residence. If, for example, your house is worth $200,000, you could recover between $20,000 and $80,000. The amount obtained will depend on your age and that of your spouse, the type of house, and its location. You will never be asked to move out or sell the house to pay off the loan. On the other hand, if the loan balance exceeds the estimated value of the house, you will be asked to pay back the interest that exceeds the estimated value of your house.
Unlike a traditional mortgage loan, you must be 60 or older to take advantage of it. There is no payment to be made, neither capital nor interest, as long as you or your spouse live in the residence. Principal and interest are repayable only on the death of the owner or on the sale of the property.
The reverse mortgage is offered by the Canadian Home Income Program ( CHIP ), a private company that has opened an office in Montreal, as well as by most chartered banks. Desjardins Group stands apart by not offering the CHIP program.
THE WEAKNESSES OF THE REVERSE MORTGAGE
Although it looks attractive, the reverse mortgage has two major weaknesses. First, the interest rate that accrues on the mortgage is higher than that applicable to a traditional mortgage. According to CHIP, the variable interest rate is 2 % higher than the rate for a traditional mortgage at financial institutions. If, for example, the variable mortgage rate is 3%, it is 5% for the reverse mortgage.
When you know the benefits of compound interest on an investment (earning interest on interest), you understand that compound interest on a loan can quickly eat away at the equity that you have worked so hard to build.
The second weakness is the costs. The borrower must pay an appraisal of the property, approximately $300, the fees of a notary, between $400 and $800, as well as the costs of closing the file, approximately $1,495. In addition, if he decides to repay his reverse mortgage before the first 36 months, he could have a penalty equivalent to 8 to 10 months of interest.
PROFITABLE REVERSE MORTGAGE?
George, 65, and Rita, 62, have a debt-free home worth $150,000. According to CHIP, they will be able to get an amount between $40,000 and $48,495. If the couple invests this money at a return of 4% per year, fewer taxes payable, which brings the real rate to 3.2% per year, they will have an income of $1,552. ($48,495 X 3.2% = $1,552)
The couple needs $12,000 a year to live on, which means that after one year they will have $38,047 left ($48,495 + $1,552 – $12,000 = $38,047). At this rate, the sum will be exhausted in less than 4½ years.
Marcel and Gabrielle, both 75, have a debt-free home worth $150,000. They will be able to obtain an amount varying between $54,995 and $62,495. If the couple invests this money at a return of 4% per year, fewer taxes payable (estimating the tax rate at 20%), which brings the rate down to 3.2% per year, their gain is $2,000. ($62,495 X 3.2% = $2,000 income)
The couple needs $12,000 a year. At the end of the first year, he will have $52,495 left ($62,495 + $2,000 – $12,000 = $52,495). In less than 5½ years, the account will be empty.
In these two cases, the couples must continue to pay the property and school taxes, the maintenance of the house, the electricity, and the water tax.
If instead of using the reverse mortgage, the two couples sell their house with a real estate agent: $150,000 – $8,466 (agent’s commission approximately 5% + GST and QST) = $141,534.
The sum is invested at a return of 4%, always less tax, which gives an effective rate of 3.2%. With needs of $12,000 a year, they will be able to live on that money for 14 years and a little bit. On the other hand, they will replace maintenance costs and municipal and school taxes with a housing costs which may be higher.
A COMPLEX PRODUCT
The reverse mortgage is a complex product. I, therefore, recommend that you consult a specialist before you start in order to know the best financial strategy to achieve your goals while respecting your personal and financial values. If you decide to use the reverse mortgage, be careful. It would be better to use it only as a last resort and to wait as long as possible before getting it.