Is a Reverse Mortgage Right For You?
Have you seen those ads that feature a happy couple on a beach somewhere, relaxing in the sun because they took out a reverse mortgage and now they can afford that trip south? It’s one of those images that strike many of us as looking too good to be true. After all, you get to stay in your home and receive a regular monthly income – tax-free – where’s the catch?
While a reverse mortgage might be appropriate in some situations, it’s not that good a deal for most of us. Let’s review how the reverse mortgage works.
A reverse mortgage allows those who are “house rich, but cash poor” to stay in their homes and draw on the equity they’ve built up to produce a regular income. Essentially, they’re taking out a life term loan against their house, with no fixed repayment schedule. The loan will eventually be paid off when the homeowners die or sell the property.
But herein lies the problem. First of all, the interest rates charged on these arrangements aren’t low – they’re generally pegged at about 1 ½% above the current five-year mortgage rate. And, since the debt keeps compounding, with no payments being made, a hefty amount can be owing when it comes time to pay the piper.
Let’s take an example. On the investment side, the rule of 72 tells us that, if the product of our rate of return times the number of years invested equals 72, that’s how long it will take us to double our money. The same logic applies to a reverse mortgage. So, if you take out a reverse mortgage of $50,000 at 7.2%, in ten years, your amount outstanding will have doubled to $100,000. Give it another ten years, and you’ll owe $200,000.
You can see the problem. In some cases, the whole value of the property when the homeowners die might be required to pay off the outstanding loan. What if the bottom falls out of the real estate market and the house isn’t worth as much as the loan? The lender has to absorb the difference – they’re not allowed to go after the other assets of the estate.
But what if, in later years, the homeowners need to move into a retirement home where more support will be available to them? Most people look to the equity they’ve built up in their homes to fund such an expense; however, with a reverse mortgage in place, there may not be much equity left.
In short, the reverse mortgage is an arrangement to be approached with extreme caution. Other alternatives, such as downsizing or using a home equity line of credit, may be more favourable in the long run. Contact us to discuss your best options
