How reverse mortgages factor into retirement planning amid rising interest rates

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Reverse mortgages are proving to be an increasingly popular retirement planning tool even though interest rates are rising and these products charge higher rates than most other mortgages.

Advisors are turning to reverse mortgages as a way for clients who are looking to delay Old Age Security (OAS) and Canada Pension Plan (CPP) benefits, to access more tax deductions, or assist with down payments on homes for their children.

Options such as a secured line of credit or mortgage refinancing have long been available for those same purposes, but there’s a growing cohort of advisors who believe a reverse mortgage is often the better option.

“There is no question that the interest rate on a reverse mortgage is going to be higher than the rate on something like a secured line of credit,” says Allan Norman, certified financial planner with Atlantis Financial Inc. and investment advisor with Aligned Capital Partners Inc. in Barrie, Ont.

“However, what you don’t get [with a secured line of credit] is protection such that if you reach your credit limit you’re going to have to make out-of-pocket interest payments.”

In contrast, with reverse mortgages, clients can choose an interest-only product in which the principal is not repaid until either the home is sold or the last borrower passes away. Neither principal nor interest payments are technically required until one of those scenarios occurs.

Today, people who aren’t able to refinance their lines of credit are applying for reverse mortgages, he says.

Jesse Abrams, chief executive officer of online mortgage provider Homewise Solutions Inc., says his company is starting to put more resources into products such as reverse mortgages because with interest rates going up, “the last thing people are going to want to do is sell their homes.”

In March, Homewise got roughly 3 per cent of its total revenue from reverse mortgages, but that has since doubled to 6 per cent, according to Mr. Abrams.

The way most reverse mortgages are structured also minimizes the impact of current interest rates because interest payments are usually based on a variable rate that moves up or down with the prime, rate Mr. Abrams says. That means even if someone were to take out a reverse mortgage today at a higher interest rate, that rate will go down whenever the prime rate falls.

If the borrower chooses not to make interest payments, the amount that will eventually be due will grow as interest accumulates on top of the principal – and the homeowner would then also be charged interest on those missed interest payments. But Mr. Norman points out that in most cases, the value of the home is also increasing.

“Home value will be close to twice the size of the reverse mortgage,” he says. “So, even if the home appreciates at a rate less than the reverse-mortgage interest rate, I find when I model these, home equity either remains the same or continues to grow.”

Tax benefits of reverse mortgages

In addition, as principal residences are exempt from capital gains taxes, the money homeowners receive from a reverse mortgage is tax-free.

“That money can be layered on top of taxable income so you can navigate the different tax brackets and maybe maximize your tax credits and government benefits,” Mr. Norman says.

Interest payments on a reverse mortgage can also be tax deductible if the money is invested to generate income, according to the Ontario Securities Commission (OSC). That’s the strategy John Donnelly, founder and president of Donnelly Advisors Group Inc. in Sidney, B.C., normally pursues.

“We usually take the whole thing up front and invest that into a segregated fund,” he says. “Then, any returns over the interest growth, we give to the client to spend.”

Another benefit of the tax-free draw, according to Mr. Norman, is it can help some people keep more of their OAS or provide them with an income if they want to delay CPP until age 70. Starting CPP payments at 70 instead of 65 can increase the amount by 42 per cent or more, experts say.

Having utilized reverse mortgages for almost 20 years, Mr. Donnelly says it “recently started to become more popular” as misconceptions that have long persisted about the products have diminished.

“I just want people to understand that there’s another option,” he says. “That stigma that they’ve had for years about reverse mortgages is no longer there.”

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