STRATEGY SHEET
July 2002
Reverse Mortgages Provide
Tax-Free Retirement Funds
© Talbot Stevens
For many retirees who are conservative investors, the drop in interest rates in the last decade has cut their retirement income in half. If your retirement funds aren't enough to meet your expenses, what are you to do? For some, reverse mortgages may be the answer.
Reverse mortgages aren't well known in Canada yet, but you will hear more about them in the future as more baby boomers head into retirement facing the reality that they haven't saved enough.
Instead of making mortgage payments to increase your home equity, reverse mortgages allow you to borrow against your property and have the interest charges deferred indefinitely until you sell or pass on.
One of the big appeals of a reverse mortgage is the fact that the money is received tax-free, with no taxes due when you receive the funds or when the mortgage is paid off.
For those needing money in retirement, a reverse mortgage is one way to get your hands on some of the equity in your house and stay in your home forever without worrying about making payments.
Generally, the interest expense is deferred, decreasing your equity in the house. If your house is worth more than you owe when you die, your estate gets the difference. However, if the mortgage balance is higher than the property value when you die, either because you live longer than expected or property values drop, the company loses.
The homeowner's risk is limited to the value of the property. Because of this, reverse mortgages are only available to those over 60, and for a portion of a home's value.
The Canadian Home Income Plan (CHIP) is the largest vendor of reverse mortgages in Canada. With CHIP, those over 62 can access between 10 and 40% of the appraised value of their home. In addition to application, appraisal, and legal fees, there is a hefty break-up fee to get out of the deal once you sign. Legal advice is required to ensure you understand what you are getting into and the ongoing conditions that must be satisfied.
A far greater expense than the one-time setup fees is the interest rate charged on the outstanding balance. The interest rate is higher than for a conventional mortgage. When this was written, CHIP's rate was about 2-3% higher than you could get from your bank or mortgage broker for the same one-year term.
A 2.5% difference in mortgage rates over a 15-year period could end up costing an extra $50,000 per $50,000 mortgaged, leaving much less for your estate.
Another concern for some is the fact that with CHIP, you can only get one-year mortgage terms. Unfortunately, there is not an option to lock in long term, now that interest rates are near 40-year lows and have appeared to bottom out.
Next month, we will explore cheaper, more flexible alternatives to reverse mortgages.