Vera and Bob Smith are typical of many retired couples in Canada — they are house rich and cash poor. They live on old age security and CPP payments, supplemented by a small private pension, and income Vera earns part-time.
To provide financial breathing room, five years ago the couple (whose name has been changed for this article), took out a reverse mortgage, tapping into the equity of their primary residence, a $500,000 waterfront property east of Toronto they have owned for decades. They also own a rental property that a relative lives in.
Vera, who is in her 70s, worked in the financial industry and understood mortgages. She liked the idea of a reverse mortgage because it would ease cashflow pressure and allow them to stay in their home longer.
They used the proceeds to pay off their primary property’s existing mortgage. That eliminated their monthly payment, because under a reverse mortgage there is no requirement to make principal and interest payments. Rather, the interest builds over the life of the loan. “That is like giving us another paycheque,” she says. Moreover, Smith adds, thanks to rising house prices, their principal residence has appreciated more than the amount of interest that has accrued on the loan. “We felt it would work for us, and it has.”
The Smiths are part of a growing number of retirees turning to reverse mortgages as a way to leverage existing assets and provide comfort. “There are so many poor millionaires across [B.C.’s] lower mainland, couples surviving on Canada Pension Plan and OAS, but who have no other pensions,” observes Richard Middleton, a financial security adviser and investment representative at Freedom 55 Financial in Vancouver, who has suggested reverse mortgages when helping clients manage their money. “It’s a de-risking strategy, lowering the risk of your entire portfolio,” he says, calling a reverse mortgage a form of “equity release,” that can be used to finance a client’s income gap or invest in assets other than real estate. “It’s a way to diversify their assets and bridge any income gap by taking some of the cream off of the table.”
Canada’s rising property prices and aging population are fueling a reverse-mortgage boom. According to news agency Bloomberg, in June 2019, the outstanding amount Canadians owed on reverse mortgages was $3.12 billion, double the amount from four years ago. Shannon Patterson, an independent Vancouver mortgage broker with VINE Group, part of Mortgage Alliance, has seen the growth firsthand. “This year, I am on track to do 15 of them,” Patterson says of reverse mortgages. “Every year it is increasing more and more.”
Reverse mortgages have been available in Canada for more than 30 years. There are currently two providers: HomeEquity Bank, which started 33 years ago, has the lion’s share of the market with its CHIP Reverse Mortgage, and Equitable Bank, which entered the reverse mortgage market a few years ago and offers products in Alberta, Ontario, British Columbia, and Quebec. Both are domestic banks subject to the Federal Bank Act and are overseen by the Office of the Superintendent of Financial Institutions (OSFI), which also oversees Canada’s six big banks.
HomeEquity focuses only on reverse mortgages and at the end of August had assets of almost $4 billion on its balance sheet, according to OSFI. Equitable Bank is an alternative lender that offers reverse mortgages, residential and commercial loans, lines of credit, and term deposits. According to OSFI, Equitable had more than $27 billion of assets at the end of August.
Paul von Martels, vice-president, prime and reverse mortgage lending at Equitable, says his company was attracted to the reversemortgage market because of Canada’s aging population and the fact Equitable is a “niche” lender with expertise delivering financial products to underserved markets. “There is a large market here,” he says, noting that seniors are retiring with larger debt loads. The share of Canadian retirees making mortgage payments rose to 20 per cent in 2018, he notes. Yvonne Ziomecki, external vicepresident, marketing and sales at HomeEquity Bank, says more seniors are hitting retirement age with insufficient savings. She cites a survey that indicates half of Canadians 65 and older have only $100,000 in savings.
Yet, more than 93 per cent say they want to “age in place” and stay in the home they live in. A reverse mortgage, can facilitate that.
So how do reverse mortgages work? There are a number of rules.
- You must be at least 55 and be the homeowner.
- It must also be your principal residence.
- The amount you qualify for is based on what is known as the loan-to-value (LTV) ratio.
The LTV is expressed as a percentage of the amount loaned in relation to the home’s appraised value. The maximum that HomeEquity lends is 55 per cent of a home’s value, while Equitable tops out at 40 per cent, but that’s only for the oldest clients. The younger you are, the less you can borrow. If a couple applies for a reverse mortgage, the loan is based on the age of the youngest person.
Reverse mortgages work similar to a home equity line of credit. However, instead of paying interest monthly, no payment is required, though you can usually pay down the loan without a penalty. The bank places a charge against the home, similar to a conventional mortgage, to secure the loan, but does not collect on it until you die, move out, or sell the property. If one spouse dies, the other can remain in the home provided he or she was included in the loan application, which is why it’s important that both spouses apply for the loan. However, reverse mortgages have conditions similar to conventional mortgages. As a homeowner, you have to ensure that you maintain the upkeep on the property and don’t let it fall into disrepair, keep it properly insured, and pay the property taxes. Failure to do so could result in a default under the loan agreement and trigger the home’s sale. As well, reverse mortgages can be limited geographically and tend to skew to larger urban centres.
However, they are a flexible product. You can take a lump sum or receive installments, accruing interest only on the amount drawn down.
They are non-amortized, which means they aren’t spread out over a 20- or 25-year term. Rather, the interest rate is simply reset periodically. For example, you could do a five-, three-, or one-year rate, or pick a variable rate. Because you make no payments on the loan, the bank takes on more risk, so the interest rates are higher, as much as one to two percentage points. For example, in October, reverse mortgage loans were in the mid fiveper-cent range for a five-year rate, while a conventional five-year, closed mortgage was in the low three-per-cent range.
As well, because you make no payments, the interest on the loan builds up over time and is added to the principal amount, so you are charged interest on interest.
However, there is some peace of mind. Reverse mortgages have a “negative equity guarantee,” explains von Martels. They are “non-recourse loans,” he says, so if house prices slump or you outlive the lender’s mortality table and suddenly the loan exceeds the property value, the bank cannot kick you out and foreclose unless you default on a condition. If the house is sold for less than the loan, the bank gets only the fair market value of the house and cannot sue for the remainder. If a home is sold, any remaining balance after the loan is paid goes to the borrower or his or her estate.
However, the likelihood that the loan will grow to exceed the value of the home is low, says HomeEquity’s Ziomecki. Typically, the LTV is around 30 per cent. “People are not taking the maximum.” She notes the average age of a HomeEquity client is 72 and the mortgage size is $170,000. At Equitable, the average age for a mortgage is 75 to 85 and mortgages typically range between $200,000 to $300,000.
Freedom 55’s Middleton, says “Canadian reverse-mortgage lenders are extremely conservative. They are not betting the farm. The loan-to-value amount they lend is small. I have never done a reverse mortgage where the equity release has been over 31 or 32 per cent.”
Also, a home typically appreciates over time. HomeEquity provided a scenario of a $500,000 home that generated a $170,000 reverse mortgage, leaving $330,000 in equity. After 10 years, the amount owed grows to $298,652. However, the home’s value has also risen to $671,958, based on a three-per-cent appreciation rate. Even after 10 years, the client would still have $373,306 in home equity.
Reverse mortgages go against conventional financial planning, which is to retire with no debt, observes Adrian Mastracci, a discretionary portfolio manager with Lycos Asset Management Inc. in Vancouver. “These things are not cheap. You are incurring interest expense,” he says, which can “put you in a very precarious position that you might not get out of too easily.” He recommends other strategies, such as reducing expenses or finding a cheaper financing option, such as a secured line of credit or a conventional mortgage.
Reverse mortgages are “a way to diversify their assets and bridge any income gap by taking some of the cream off of the table.” — Richard Middleton
However, that still entails a monthly payment and is not always available to seniors, especially with the new stress tests on mortgages, notes mortgage broker Patterson. Traditional financing is based on income, and seniors don’t always qualify, she says. As well, products like lines of credit are really demand loans that can be called in at any time, including after a spouse dies. The remaining spouse may have to “requalify,” she says. “It’s stressful.”
Experts say there are a number of reasons why seniors might want to use a reverse mortgage. They might need to do renovations to accommodate their aging, such as ramps or wider door frames for wheelchairs, scooters, or walkers, or to put a new roof on the house, or fix a kitchen or bathroom. Patterson notes that reverse mortgage money is tax-free. If a senior had to pay for such capital improvements, by taking a lump sum out of their RRSP, he or she would incur taxes. Moreover, that could bump them to a higher tax bracket the following year.
Of course seniors could always downsize, buy a cheaper home, and bank the sales proceeds. However, in today’s high-priced market, it’s not easy to do, the experts say. Moreover, there are closing costs, real estate commissions, and moving expenses that must come out of the sale proceeds. One option is to downsize and take a reverse mortgage on the new property, which can increase the amount you receive.
Of course, like any financial product, reverse mortgages have fees, which are in the $2,000 range, depending on which company you choose. That covers things like the cost of setting up the mortgage, legal fees, and the home appraisal, which can be paid for out of the proceeds.
Retired homeowner Smith says, “you have got to live with a little higher interest rate,” but you are building equity in your home.
“You are ahead in the game and still got lots of value in your house.”