For retirees looking at their home as a source of income, there are three possible routes. ‘One is selling the house outright and freeing up capital. A second option is securing a line of credit, and then the third option is a reverse mortgage.’Kevin Van Paassen/The Globe and Mail
Anything that sounds easy comes with risks. And one risk of using a reverse mortgage to pay for retirement, albeit a rare risk, is foreclosure.
Reverse mortgages are advertised as a way to draw money out of your home for retirement, an alternative to selling the home or taking out a loan, such as a home equity line of credit. With property prices so high, accessing some of the money wrapped up in the value of your home sounds enticing.
The reverse mortgage provider – there is only one in Canada nationally, HomEquity Bank – loans up to 55 per cent of the value of the home. The money can then be used to pay for various retirement costs. Payment for that loan isn't due until you no longer live in the house, whether you moved out or put the house up for sale, or you've died.
The appeal, HomEquity Bank says, is that retirees don't have to worry about making regular interest payments, as they do with traditional loans. Yet, a reverse mortgage steadily drains home equity over time and the interest compounds. That is, the debt grows, indeed like a regular mortgage but all in reverse.
And unless you are able to meet other financial obligations on the house, foreclosure is possible.
This has raised alarm bells in the United States, where there are many more reverse mortgage providers. Last year the Consumer Financial Protection Bureau fined three companies $800,000 (U.S.) for using deceptive advertisements to sell reverse mortgages. The bureau ordered the companies to stop the misleading ads.
Yet foreclosure can happen in Canada, too, if the homeowner doesn't pay property tax and home insurance, as well as maintain the value of the property by keeping the home in good shape.
"If you don't, we will work with you. Perhaps we can advance additional funds from what you are eligible for. We could potentially help you refinance. You can get help from family members," said Yvonne Ziomecki, senior vice-president of marketing and sales.
Nevertheless, the bank has sometimes had to foreclose on homes in cases where a home wasn't insured and property taxes weren't being paid, to the extent that the government was registering legal claims on the homes. "It would be the same as any other bank. It would be the same as TD or RBC [Toronto-Dominion Bank or Royal Bank of Canada]," Ms. Ziomecki said.
"It happens in a very small number of cases," and in most circumstances, the bank is able to find a resolution, she added. "If it goes too far, it's probably a few years of unpaid taxes and a complete lack of insurance. But we do try to work with people as much as possible."
HomEquity Bank is also careful to raise other cautionary notes.
The bank doesn't automatically lend the maximum 55 per cent of a home's value for every client. The lending limit depends on the location of the home, type of property and the age of the homeowner. HomEquity also advises not to borrow excessive capital, but to preserve as much equity in the home as possible. You also have to be 55 years old or older to qualify in Canada.
If a financial strategy is too complicated for your liking, or you simply don't understand the risks, don't do it, financial professionals warn. Some advise staying clear of reverse mortgages, seeing them as a last-ditch means to pay retirement costs, because it eats away the equity retirees have in their home.
But most planners seem to take a more measured approach. Bev Moir, director of wealth management and senior wealth adviser at ScotiaMcLeod in Toronto, sees it as the least desirable of three possible options. She noted, though, that she tends to deal with higher net-worth clients, therefore those who do have more than one option.
For retirees looking at their home as a source of income, she pointed to three possible routes. "One is selling the house outright and freeing up capital. A second option is securing a line of credit, and then the third option is a reverse mortgage."
One disadvantage is that reverse mortgages have higher interest rates, which HomEquity said is necessary to cover the extended risk of lending typically for much longer periods of time, that is, lending until a borrower leaves his or her home.
With a reverse mortgage, Ms. Moir warned, "interest is compounding. It's growing." The quandary then for someone taking out a reverse mortgage is that they are likely doing so because they need income during retirement. Yet interest on the loan is compounding and the equity in the home is diminishing, and this can make it increasingly difficult to meet large expenses such as home repairs, she said.
Then again, a reverse mortgage may be one of the only loan options for those who can't qualify for a traditional line of credit, because they lack sufficient income. "The biggest difference with our product is that there are no payments that have to be made," Ms. Ziomecki at HomEquity Bank said, since the loan comes due only when the borrower no longer lives in the house.
The problem with the alternative, with a line of credit, is the inability some retirees may have with making monthly interest payments, let alone paying down the principal, Ms. Ziomecki said.
"How are you going to service the line of credit? Where are you going to come up with the money? In some instances, it actually encourages people to kite, which means withdrawing money out of the line of credit to make payments on the line of credit," she said.
Still, despite the strong caution expressed by many retirement planners, some see reverse mortgages as a strategy even for those who could go with other options.
"I don't think it's a last-ditch effort. I think it's a choice that people are making," said Stav Adler, a retirement analyst at PI Financial in Vancouver.
He acknowledged the downsides, such as the equity in the house being lower when the loan is eventually paid. But what if the property value has leapt higher? Even though the interest rate may be higher on a reverse mortgage, the higher real-estate value could make up for it, he argued.
"So it really depends on the circumstances," Mr. Adler said.