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Understanding Reverse Mortgage in Canada, Advantages & Disadvantages, How it Works & Who Qualifies?

Reverse mortgages have become a popular avenue for Canadians aged 55 and older to unlock the equity accumulated in their homes. HomeEquity Bank, the largest reverse mortgage provider in the country, reported a significant increase in activity, originating $1 billion in new loans in 2022, marking a 30% rise from the previous year.

How Does a Reverse Mortgage Work in Canada?

A reverse mortgage functions as a financial tool that enables homeowners to convert home equity into cash. With this arrangement, a homeowner borrows money based on their current equity, and the repayment occurs when the home is eventually sold. The term “reverse” mortgage is used because it involves drawing from the equity, depleting it, rather than accumulating it.

For older or retired homeowners facing a need for cash, especially those uninterested in selling their homes or relying on alternative investments for long-term income, the options can be somewhat limited. Traditional refinancing may not be viable if their retirement income cannot support additional mortgage payments.

In such scenarios, a reverse mortgage offers a solution by providing the necessary cash while allowing the homeowner to maintain ownership of their appreciating real estate. This financial flexibility can be particularly beneficial for retired individuals living on fixed incomes, offering peace of mind and the ability to tap into the value of their homes without the need to sell.

However, before pursuing a reverse mortgage, individuals should carefully consider the terms, implications, and alternatives, ensuring it aligns with their financial goals and needs.

Who provides reverse mortgages in Canada?

In Canada, the two primary providers of reverse mortgages are HomeEquity Bank, which initiated its reverse mortgage offerings in 1986, and Equitable Bank, established in 1970. Despite being Schedule 1 banks, neither maintains physical branches for in-person visits.

HomeEquity Bank offers its reverse mortgage products directly and through major Canadian banks, select credit unions, mortgage brokers, and financial planners. Conversely, Equitable Bank’s reverse mortgage products are accessible exclusively through independent mortgage brokers specializing in reverse mortgage services.

While HomeEquity Bank extends its reverse mortgages across all Canadian provinces (excluding territories), Equitable Bank limits its lending to specific areas in British Columbia, Alberta, Ontario, and Quebec.

Types of Reverse Mortgages

Similar to conventional mortgages, reverse mortgages come in various types. When selecting a reverse mortgage product, one must decide between open or closed mortgage agreements and opt for either a variable or fixed mortgage rate.

Additionally, reverse mortgage products differ in how they dispense funds. Some allow borrowers to access the entire mortgage amount upfront, while others offer a combination of an initial lump-sum payment and subsequent scheduled or discretionary withdrawals.

Understanding the CHIP Reverse Mortgage Canada

The CHIP Reverse Mortgage, Canada’s oldest and most widely-used reverse mortgage, was HomeEquity Bank’s inaugural product, initially known as the Canadian Home Income Plan. Rebranded as the CHIP Reverse Mortgage in 2014, it now constitutes one of several reverse mortgage options offered by the company.

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How do Reverse Mortgages Work in Canada & Who Qualifies for it?

While reverse mortgages are generally straightforward, understanding eligibility criteria, interest rates, and fund disbursement and repayment methods is crucial.

Reverse Mortgage Eligibility To be eligible for a reverse mortgage

  • The borrower must be at least 55 years old, and all other individuals on the home’s title must also meet this age requirement.
  • The borrower must own and reside in the home as their principal residence.
  • The home’s appraised value should be at least $200,000 (HomeEquity Bank may require a minimum of $250,000).

Applying for a Reverse Mortgage Initiating a reverse mortgage application typically involves completing an estimate on the lender’s website. The lender assesses factors such as age, home location and condition, and appraised value during the application process.

What is the interest rate on a Chip Reverse Mortgage?

Interest Rates and Fees in Canada Reverse mortgages often come with higher interest rates, and as of June 13, 2023:

  • HomeEquity Bank’s CHIP Reverse Mortgage rates ranged from 7.49% fixed (8.02% APR) to 9.65% variable (10.06% APR) for five-year terms.
  • Equitable Bank’s reverse mortgage rates ranged from 7.24% (7.264% APR) for a five-year fixed-rate loan to 8.73% (10.26% APR) for a six-month fixed-rate loan.

Both lenders charge fees, and prepayment penalties vary based on the terms of the contract.

How Do You Receive Funds After Approval?

Receiving Reverse Mortgage Funds Upon approval, borrowers can access up to 55% of their home equity. They can choose a single lump sum or a combination of an initial advance and smaller payments over time based on financial needs.

How Do You Pay Back a Reverse Mortgage?

Paying Back a Reverse Mortgage Repayment flexibility is a key feature, with no scheduled principal or interest payments required until the home is sold, the borrower moves out, or the last borrower passes away. However, interest accrues during this period.

Risk and “No Negative Equity” Policies Both Equitable Bank and HomeEquity Bank have “no negative equity” policies, ensuring borrowers never owe more than their homes are worth, provided they adhere to their mortgage contracts.

Refinancing a Reverse Mortgage While refinancing a reverse mortgage might not seem necessary, significant home appreciation may prompt lenders to allow refinancing for revised mortgage terms. However, it involves risks and potential prepayment penalties.

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Is a Reverse Mortgage a Good Idea?

The decision to pursue a reverse mortgage depends on individual circumstances. It can be a solution for addressing financial needs, but sacrificing home equity poses long-term considerations, impacting future options.

Considerations for Reverse Mortgages Reverse mortgages are suitable for those:

  • Physically and financially able to maintain their properties.
  • Planning on staying in the same house for the rest of their lives.

Conversely, reverse mortgages are unsuitable for those:

  • Facing difficulty in maintaining their homes.
  • Wishing to leave their homes to their descendants.
  • Who would benefit from selling their homes and keeping 100% of the equity.

Questions to Ask Before Applying Before opting for a reverse mortgage, ask pertinent questions such as:

  • How will taking out a reverse mortgage affect other financing options?
  • What happens to the home and reverse mortgage upon the borrower’s death?
  • Should all loan funds be accessed at once or gradually?
  • What if property taxes, insurance, or home maintenance become challenging?
  • Is a reverse mortgage the best option considering individual circumstances?

Alternatives to a Reverse Mortgage

If the costs and risks associated with a reverse mortgage are not suitable for you, there are alternative ways to access cash, though some may involve making sacrifices:

  1. Sell Your Home and Downsize:
    • By selling your house, you can access all your equity without incurring reverse mortgage fees or interest charges.
    • Downsizing involves purchasing a newer, smaller home with the sale proceeds, providing cash and an appreciating real estate asset.
    • Downsides include detaching from your current home and potential challenges re-entering the housing market.
  2. Sell Some of Your Other Investments:
    • Liquidating a portion of your robust investment portfolio can generate the needed cash.
    • Consult with a financial planner to discuss implications such as potential taxes and the impact on long-term financial stability.
  3. Take on a Tenant:
    • Utilize Canada’s tight rental market by renting out an extra room or basement suite.
    • This not only generates cash but may also lead to a tenant helping with property maintenance.
    • Becoming a landlord involves risks, and careful tenant screening is crucial.
  4. Apply for a HELOC (Home Equity Line of Credit):
    • A HELOC allows you to convert home equity into cash, but it is viable only if you have a steady income.
    • Lenders evaluate your financial stability before approval, and failure to repay can lead to the risk of losing your home.
  5. Apply for a Home Equity Loan:
    • Similar to a HELOC, a home equity loan provides cash but requires a steady income for approval.
    • Home equity loans may be easier to qualify for than reverse mortgages but come with a strict repayment schedule, and non-compliance could result in home forfeiture.
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Advantages and Disadvantages of a Reverse Mortgage

Advantages:

  1. Additional Income:
    • Unlocking equity increases cash flow.
  2. No Regular Repayments:
    • While interest accrues, monthly payments are not required.
  3. Age in Place:
    • Access equity without selling or moving.
  4. “No Negative Equity” Guarantee:
    • You won’t owe more than the property’s value.
  5. Undisrupted Income:
    • Cash from a reverse mortgage doesn’t affect Old-Age Security (OAS) or Guaranteed Income Supplement (GIS) benefits.

Disadvantages:

  1. Higher Interest Rates:
    • Rates are typically higher than HELOCs or traditional mortgages.
  2. Reduced Equity:
    • Borrowing and accruing interest deplete home equity.
  3. Initial Costs:
    • Administration, appraisal, and legal fees may apply.
  4. Prepayment Penalties:
    • Selling before the term’s end incurs prepayment fees.

What is the downside of reverse mortgage?

  1. High Interest Rates:
    • Reverse mortgages often come with interest rates higher than traditional mortgages or home equity loans.
  2. Fees:
    • Borrowers are required to pay various fees, including administration, appraisal, and legal fees, which can add to the overall cost.
  3. Prepayment Penalties:
    • Prepayment penalties may apply if you choose to sell your home before the end of the loan term, adding an additional cost.
  4. Reduced Home Equity:
    • As borrowers access funds and interest accrues, the equity in the home diminishes, leaving less money from the eventual sale.
  5. Limited Inheritance:
    • Borrowers may leave less inheritance for their heirs due to the reduction in home equity.
  6. Complexity of Terms:
    • The terms and conditions of reverse mortgages can be complex, and borrowers need to fully understand the implications before entering into an agreement.
  7. Potential Impact on Benefits:
    • The cash received from a reverse mortgage may affect eligibility for certain government benefits, such as Old-Age Security (OAS) and Guaranteed Income Supplement (GIS).

Interest Rates on Reverse Mortgages in Canada

  1. High Rates:
    • Interest rates on reverse mortgages in Canada can be very high, often exceeding 10%.
  2. Varied Rates:
    • Rates vary, but even the lowest reverse mortgage rates are generally well above 6%.
  3. Term-Related Rate Changes:
    • Typically, longer terms may offer slightly lower rates, but rates remain relatively high compared to other financing options.

It’s important for potential borrowers to carefully consider the downsides and thoroughly research the terms and conditions, as well as explore alternative financial solutions before opting for a reverse mortgage.