The mortgage that grows - MoneySense

The mortgage that grows

Reverse mortgages can destroy your home’s value

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Canadians have seen their homes rocket up in value over the last decade and it’s hard not to let that sudden wealth go to your head. If your house is suddenly worth half a million dollars, why shouldn’t you use some of that equity to take a holiday, build a deck, or send your kids to a good school?

You’ve probably seen the TV spots offering you the chance to unlock your home’s value by taking out a reverse mortgage. You may have heard the “Wouldn’t it be nice?” refrain from CHIP Home Income Plan or seen ads from Seniors Money, a new player, and wondered if you too could tap into a little of your built-up equity.

At first glance, it’s a tempting proposition. But not after you read the fine print. If you take out a reverse mortgage for $200,000, you better enjoy that money while it lasts. Because in 15 years you’ll be in the hole for more than $600,000.

A mortgage in reverse

Taking out a reverse mortgage is like getting a loan that’s secured by your house. You have to be at least 60 to qualify, but as long as you stay put, you don’t have to make any payments. You can use the money for anything you want. Since you’re essentially taking out all the money you put into your house over the years, you don’t have to pay taxes on the cash or worry about having your Old Age Security or Guaranteed Income Supplement clawed back.

Advocates of reverse mortgages say these deals let you maintain control of your home. You can’t be forced to move or give up your home, and you never have to pay back more than your home’s value. But if you do decide to move for any reason, then the full amount of the loan plus years of interest becomes due. That’s when the situation can get scary.

There’s no going back

If you were 72 years old and owned a detached home in Toronto worth $460,000, you could borrow up to about $200,000 in cash from the CHIP Home Income Plan, which is currently the main provider of reverse mortgages in Canada. The problem is that CHIP charges a very high interest rate on that loan, and it’s compounded twice a year, with the interest payments rolled into the amount you owe.

That means your debt balloons quickly, and you can burn through your home’s value in less time than you think. In just 15 years you would owe more than $650,000. Unless your home increased in value at a higher rate than inflation, you would have pretty much completely devoured your home’s worth. When you die or move and your home is sold, almost all of the money would go to CHIP.

It’s rare that a home’s equity is completely devoured, according to CHIP, and if you’re not planning on leaving any money to your kids, you may not care if it is. But you should keep in mind that life can throw you some unexpected curveballs. For instance, if your health deteriorates 15 years into the plan and you have to sell your house and move into a nursing home, you would find yourself faced with a staggering debt and little left over to pay for health care. “Once you’re into a reverse mortgage, you can’t change your mind,” says Talbot Stevens, a financial educator and author of Financial Freedom Without Sacrifice. “It’s a permanent solution.”

Safer options

Stevens says a home equity loan may be a better solution.

In mid-November, most banks were charging 6.25% for such loans, compared to 8.75% and higher for the CHIP loans. It’s true that you have to pay the interest on a home equity loan every month, but Stevens says you can just borrow a bit more than you need and pay the interest with borrowed money as you go.

Such loans make sense if you want to go on a big trip shortly after retirement, or you want to do some home improvements, and you’re prepared to pay back the loan in a few years. A reverse mortgage also lets you pay back the loan at any time, but a home equity loan gives you more flexibility and you won’t end up $650,000 in debt on a $200,000 loan.

There’s one final option, and it’s the only true way to unlock all of the value in your home: Sell it. Many people have an emotional attachment to the place in which they raised a family, but there’s simply no other way to get half a million dollars out of a half-million dollar home.

Yes, you’ll have to move to a smaller place, but you can invest the profits from the sale so that you’ll have a nice place to live and some extra income too. Best of all, you’ll be in a more secure position, because you’ll have a nest egg to deal with surprises. And if the kids complain that now they have to host Thanksgiving? Just remind them of the alternative. You’ll be amazed by how quickly they come around.

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