Why a reverse mortgage should be a last resort for most Canadian retirees

Despite the high profile, there’s not a huge number of reverse mortgage products available in Canada. The two main ones of which I’m aware are Equitable Bank and HomeEquity Bank (a.k.a. CHIP Reverse Mortgage). According to Canada.ca, reverse mortgages typically cost more than conventional mortgages and home equity lines of credit (HELOCs). This is because the borrower is not required to make payments, so the lender must wait years to get its money back—seven to 12 years, on average.

My personal take is that reverse mortgages should be considered only as a last resort for homeowners who really need a bit of tax-advantaged monthly income, who don’t have heirs to whom they can bequeath their estate, and who want to stay in their home as long as possible.

Advice-only financial planner Jason Heath, of Objective Financial Partners Inc., agrees. “I think retirees should generally look to their investments or a home equity line of credit before a reverse mortgage. And then consider downsizing or selling and renting as options as well.”

The problem with a HELOC or a traditional mortgage is a borrower is subject to the same income criteria as any other homeowner. And retirees typically won’t qualify for much.

Who should consider a reverse mortgage in Canada

If you do decide to take out a reverse mortgage, ideally, there are no heirs, or they are so well-heeled they won’t mind if they inherit a bit less: like annuities, reverse mortgages reduce the capital available for your estate. I do have an acquaintance who has no heirs, who bought a Toronto home decades ago and is sitting on a fair bit of home equity. I couldn’t think of a reason to talk him out of it, and he seems to be quite happy in retirement, still in his home and generating enough cash for a modest retired lifestyle. 

Author P.J. Wade is well known for her 1999 book, Have Your Home and Money Too (Horizon Pubs & Distributors, April 1993), which neatly sums up the appeal of reverse mortgages. The quote that sticks out in my mind when I once interviewed her was that reverse mortgages can be “your best friend or your worst enemy… your choice.” 

What is a reverse mortgage?

Matthew Ardrey, senior wealth advisor at Toronto-based TriDelta Financial says “a reverse mortgage simply is leveraging your home after age 55. There are several institutions that will create a loan structure secured against the value of your home, which you can then draw upon periodically or in a lump sum. The maximum limit they will lend is 55% [of the home’s value], though it may be less than that. One of the benefits they state is your income is tax-free! How nice of them to give you income from a tax-free asset on a tax-free basis.”

Doing the math on reverse mortgages

You may infer from his tone that, like myself, Ardrey is not a huge proponent of these structures. He uses an example that is provided on one of the reverse-mortgage provider websites to illustrate possible problems with reverse mortgages. It involves a house worth $600,000 and the home owner draws $150,000 in year one with an interest rate of 6.34%. After only five years the accumulated interest will be $54,939.

“This leaves a total outstanding now of $204,939, with the interest owing being 25% of the balance owing after only five years,” says Ardrey. “As time goes on, this can overtake the entire value of the home. Thankfully, they do note that there is no negative equity, but there is not much left at the end of the day for the home owner or their heirs.” 

Heath points to the fact that reverse mortgage rates tend to be much higher than traditional sources. “A borrower can expect to pay at least a couple percentage points more than mortgages and lines of credit. But if you read the fine print in your home equity line of credit agreement, the lender typically reserves the right to decrease your limit or even call the outstanding balance.”

So, homeowners should not count on their HELOC being available when they need it.

Right now, reverse mortgage variable rates are in the 9.5% range, while 5-year variable mortgage rates are about 6%. And the reverse mortgage 5-year fixed rates are about 7%, and 5-year fixed mortgage rates are about 5%. HELOC rates are generally 1% above prime, so they’re currently around 7.95%. “There is definitely a premium paid to take advantage of reverse mortgages,” says Heath.  

Ardrey raises another concern: how retirement living care can be paid for. “Often a home can be sold when a senior moves into retirement living, allowing them to pay for this care. In this example, the ability to use the home for this purpose would be significantly impaired.”

He suggests that instead of using a reverse mortgage that could cripple the financial future, retirees need to look honestly at their situation and the lifestyle they can afford. “Though it may not be preferable to sell their home and live somewhere else, it may also be their financial reality. This speaks to the value of planning ahead to avoid being house-rich and cash-poor.”

What are the alternatives to a reverse mortgage for Canadian retirees?

Allan Small, senior investment advisor with IA Private Wealth Inc., says reverse mortgages “have not played a part in any of the retirement plans and retirement planning that I have done so far in my career. I think the reverse mortgage idea or concept, for whatever reason, has not caught on.” Also, “those individual investors I see usually have money to invest, or they have already invested. Most downsize their residence and take the equity out that way versus pulling money out of the property while still living in it.” 

Finance professor and author Moshe Milevsky told me in an email, that when it comes to reverse mortgages—or any other financial strategy or product in the realm of decumulation—“I always ask this question before giving an opinion: Compared to what?” He worries about the associated interest-rate risk, which is “difficult to control, manage or even comprehend at advanced ages with cognitive decline.”  

What are the alternatives to a reverse mortgage? Is it selling the house and moving to downsize? Or, as Milevsky asks, “Is the alternative reducing your standard of living? Is the alternative taking a loan from a local bookie? It’s the alternative that determines whether the reverse mortgage is a good idea or not,” he says. “Generally, I will not rule them out and I think they will continue to grow in popularity among retiring boomers, but I wouldn’t place them at the very top of the to-do list when you get to your golden years.” 

Read more Retired Money columns:

• Why these authors want you to spend your money and die with $0 saved
• Canadian seniors, watch out for these scams
• How to double your CPP income
• RRSP to RRIF, and LIRA to LIF: How it all gets done

About Jonathan Chevreau

As MoneySense’s Investing-Editor-at-Large, he is also author of Findependence Day and co-author of Victory Lap Retirement. Reach him at [email protected], where he is the founder of Financial Independence Hub.

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