What Is A Reverse Mortgage? (How Reverse Mortgages Work In Canada)

If you’re a senior homeowner, you’ve probably heard of a reverse mortgage before. Many retirees take out a reverse mortgage to boost their retirement income, but it often surprises people to learn that you can use a reverse mortgage for so much more than that. It can be used to pay off debts while staying in your current home, help younger family members purchase their own first home, and even to purchase your dream vacation property.

Below, we’ll deep dive into how exactly a reverse mortgage works, all the ways you (and your loved ones) can benefit from a reverse mortgage, and things to carefully consider before applying for one.

What Is A Reverse Mortgage?

Put simply, a reverse mortgage is a loan product that allows any homeowner who is over the age of 55 to borrow up to 55 percent of the value of their home. Unlike a regular mortgage product that you use to buy a home, a reverse mortgage does not require you to make any loan payments. In fact, you don’t have to pay anything back until you either sell your home or pass away.

How Does A Reverse Mortgage Work?

A reverse mortgage works more like a line of credit than a traditional mortgage. Instead of the homeowner making payments to the lender, the lender makes payments to the homeowner. Like we mentioned above, the homeowner can borrow up to 55 percent of the value of their home, and they get to choose how to receive their money—as a lump sum, regular installments, or a combination of both.

As with a regular mortgage, the home is the collateral for a reverse mortgage. When the homeowner sells the house or passes away, the reverse mortgage will need to be paid in full including the accumulated interest. In most cases, the proceeds from the home’s sale goes to the lender to repay the reverse mortgage’s principal, interest, mortgage insurance, and fees.

It’s worth noting that the homeowner only pays interest on the money actually spent, so just because you can take out 55 percent of your home’s value, you don’t necessarily have to. You can draw on it as needed and the interest is rolled into the loan balance so that you don’t have to pay anything up front. You only have to pay when you sell the house or pass away.

You heard right—you don’t have to make any payments until you decide to leave the house or the last surviving spouse on title leaves the property. Of course, at this time you’ll have to pay back the mortgage in full, which can be done from the proceeds of your home’s sale, and any remaining money once paid out is yours (or rather, your beneficiaries) to keep. You can also elect to make payments over the life of the loan if you choose, but it’s not required.

How Much Does A Reverse Mortgage Cost?

As far as rates go, reverse mortgage rates are higher than conventional mortgage products or lines of credit. The reason being is that homeowners don’t have to make any regular payments, which makes it a riskier option for lenders. Lenders solve for this risk with a higher interest rate. Still, reverse mortgages have lower interest rates than other loans you might consider.

(Source: HomeEquity)

The reverse mortgage interest rate and the closing and administrative cost are added together to determine the annual percentage rate (APR). The APR is calculated by determining what the total interest cost would be over a five-year period, then adding the closing fee, and turning that total cost into an annual rate.

Here’s an example of how the APR would be calculated for a reverse mortgage:

(Source: HomeEquity)

Similar to conventional mortgages, reverse mortgages are available in both fixed terms and variable terms. Variable rates fluctuate over the course of the term, whereas fixed rates are set for a determined period of time. Fixed rate reverse mortgages are available for a six-month, 1-year, 3-year, or 5-year period. Homeowners typically prefer longer periods, but you should talk to your mortgage specialist to see what the best option is for you! 

How Do You Qualify For A Reverse Mortgage In Canada?

The Canadian government makes it easy for homeowners over the age of 55 to qualify for reverse mortgages. Unlike all other mortgage products, lenders don’t typically review your income or credit as part of their approval process for a reverse mortgage. (In fact, if you’ve recently suffered a consumer proposal, a reverse mortgage could be a great way to pay off that debt!)

What Lenders Typically Look At

1. Your age. You have to be 55 years of age or older to qualify.
2. The equity you have in your home. You must own your home outright or have at least 50% equity of the home. This must also be your primary residence, and you have to be living here for a minimum of 6 months. 
3. The appraised value of your home. The home must be valued at a minimum of $200,000 in Canada.
4. The location of your home.

Who Benefits From A Reverse Mortgage?

There’s a lot of misinformation out there about reverse mortgages. The truth is a reverse mortgage is an excellent way to get the funds you need to stay in your home as long as you like and to fuel your retirement savings. But that’s not all you can do with your proceeds.

Here are some of the other ways you can use your proceeds from a reverse mortgage:

• Supplement your income. The OAS/CPP and other government benefits you receive can help cover expenses but it’s rarely enough. A reverse mortgage can help you tap into your biggest nest egg—your home—to provide you with the income you need to cover all your expenses and live comfortably. 
• Repay high-interest debts (e.g. other mortgages). You can use the proceeds from the initial advance to pay off your existing mortgage and any other liens registered against your property. 
• Purchase a vacation property. How does spending half the year down south during the winter sound? Put a reverse mortgage on your current home and use the money to purchase a vacation property.
• Purchase a bigger home. Short on the down payment to buy a new home? Use the down payment from the sale of your current home to buy the property, and then add a reverse mortgage on the new home to avoid taking out a new mortgage.
• Covering moving or renovation costs. If you’re facing unexpected renovation or moving costs in retirement without the budget to cover it, a reverse mortgage can provide the money you need.
• Help a family member buy their first home. If a child or grandchild cannot save enough for a down payment to buy a home, you can add a reverse mortgage to your home and use some of the money to help them buy their first home.
• Travel. Wouldn’t you love to travel the world and not have to worry about digging too deep into your retirement savings? Your reverse mortgage can fund that, too!

Pros And Cons Of A Reverse Mortgage

A reverse mortgage is a unique loan that allows senior homeowners to borrow money in a relatively straightforward way—and to use the money however they want. But like any other loan, it has a few drawbacks, too. Here’s a complete overview of the pros and cons of a reverse mortgage.

Pros:

• Simple qualification!
• You don’t have to make monthly mortgage payments.
• The money you borrow is tax-free and does not affect your Old-Age Security or Guaranteed Income Supplement.
• You can decide how you want to receive the money.
• You can decide how you want to spend the money.
• You can age in place, in the home you love.
• You maintain ownership of your home and therefore can continue to benefit from surging Canadian home values if you decide to sell your house down the line.
• You don’t have to pay back the loan or interest costs until you sell the home or pass away.

Cons:

• As you accumulate interest on your loan, equity in your home will go down and your debt load will increase.
• Interest rates are higher than typical mortgage rates.
• The only way to get out of a reverse mortgage is to sell your home or pass away. You’ll be subject to a penalty if you sell the home or pass away within three years of taking out the reverse mortgage. (However, this penalty reduces over time and essentially disappears after five years. And if you need to move into a care home before the maturity date is due, the prepayment penalty is reduced.)
• A reverse mortgage, like a regular loan, could impact your ability to borrow more money in the future, so if you use it toward helping your children it’s important to have a financial plan and budget in place to cover your future costs.
• If you pass away, the amount you borrowed plus interest must be repaid within a specified period of time. If your spouse has already passed, this means your beneficiaries will have to pay your mortgage in full. If they do not have the money on hand to do so they would need to sell the property and pay out the amount from the proceeds. (The good news is that property values in Canada have been increasing, and any appreciation made on the home is yours, so that means there should be enough money left over from the sale of the property to pay off the loan and for your beneficiaries to have inherited something.)

How Do I Apply For A Reverse Mortgage?

Two financial institutions officially offer reverse mortgages in Canada: HomeEquity Bank, with its “CHIP” reverse mortgages, and Equitable Bank, which offers reverse mortgages in select major cities. Recently, however, a number of other lenders have sprung up offering a range of programs based on the term length and the type of advance—ad/hoc, pre-scheduled, or upfront lump sum preferred.

It’s important to keep in mind that reverse mortgages come with costs that may include a set-up fee and a home appraisal charge. Taking out one of these loans is not a light decision, so it’s wise to seek out professional advice from a mortgage specialist.

If you’re interested in learning more about reverse mortgages, reach out to Pineapple’s experienced mortgage brokers—we’re here to understand your unique needs, match you with the right product, and negotiate the best deal on your loan on your behalf.