September 17, 2013
Many Canadians find themselves in a quandary, whereby they are "house-rich but cash-poor". This dilemma means that all of your assets are tied up in the equity of your home, yet you have no cash on hand to pay for immediate needs. These needs can include medical bills, roof repairs, or weekly living expenses. Many senior citizens tend to find themselves in this scenario. After nearly 40 years of making mortgage payments, their home is finally paid off. Yet their pension incomes are not enough to fund basic living expenses.
This is when a reverse mortgage may be a good option.
A reverse mortgage allows you to release the equity in your home. The lender will advance you a lump sum of money and you make no monthly payments on this amount. But, the catch is that the accrued interest is added to the loan balance — and interest rates on reverse mortgages are often higher than those on traditional ones or lines of credit. As this interest accrues, your mortgage starts to grow. The money is eventually paid back when you die or sell your house.
Currently in Canada, there is only one provider of reverse mortgages and it is for people aged 60 and over. HomeEquityBank operates the CHIP Home Income Plan. Reports state that the agency expects to hit $1-billion in loans outstanding during the fourth quarter.
If you're a senior citizen considering a reverse mortgage (or perhaps you want to review this option for your elderly parents), there are some factors to take into account.
High interest rates: As mentioned earlier, interest rates on reverse mortgages are higher than those found on traditional ones or lines of credit. Under the CHIP Home Income Plan, the rate is 5.9% on a fixed, five-year mortgage. Compare that with rates as low as 3.5% on a conventional five-year mortgage instead.
Compounding interest: Because you are not making any monthly re-payments, the interest begins to compound. Compounding interest means that you are paying interest on top of the interest. When you die or sell your home, all of that money will have to be repaid. This leaves less cash for your loved ones or to pay upcoming bills and expenses.
Upfront costs: To apply for a reverse mortgage, you must pay some upfront costs. Reverse mortgages require a home appraisal fee ($200 – $400), independent legal advice ($400 – $600), plus closing/administrative costs ($2,000). Once you add all of this up, you are paying more than $2,000 just to get the reverse mortgage in the first place.
Cash on hand: With a reverse mortgage, the equity is released from your home. The lender gives you a lump sum of money or doles it out to you in stages. You can take care of immediate needs and general living expenses.
No monthly payments: You make any interest or principal payments until you die or sell your house. This is a particularly huge advantage for those who are "house-rich but cash-poor", who would not be able to afford monthly payments on any type of loan.
Borrower will never default: When it is time to pay back your reverse mortgage, all you'll have to repay is the fair market value of your home. This means you will never default on the final payment, nor will have to dig into your other savings to pay back the loan.
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