It’s never a great time to be an older cash-poor homeowner. But now is an exceptionally bad time.
Seniors who can’t make ends meet are not only watching their cost of living jump, their home value is falling and their debt burdens are surging.
Increasingly distressed retirees are looking to reverse mortgages as a way out. That’s where you borrow up to 55 per cent of your home value, depending on your age, location, existing financing and property type, and no payments are made until you move out or die. Problem is, reverse mortgage rates are at their highest in well over a decade.
What does that mean? It means significant equity loss for new reverse mortgage borrowers.
An example
Take a 70-year-old who gets a reverse mortgage today for 33 per cent of her $1-million home. Assume a typical five-year rate of 7.99 per cent and 2 per cent annual home value appreciation.
This reverse mortgagor would see today’s high interest rates deplete almost $55,000 of her equity in five years. That’s despite the home appreciating at our assumed 2 per cent a year.
Had this borrower got the very same reverse mortgage one year ago when rates were 5.14 per cent, her net home equity would actually increase by $8,300 after five years. The measly 2-per-cent home appreciation would have more than offset the interest expense.
(If you want to run your own scenarios, HomeEquity Bank has a calculator online at chipadvisor.ca/financial-illustration-calculator.)
What this means in practice
If you considered reverse mortgages an unappealing fallback last year, they’re almost a last resort today. That’s what happens when rates launch almost 300 basis points in 12 months. (There are 100 basis points in a percentage point.)
Let’s be real, however. Those contemplating a reverse mortgage usually don’t have a lot of options. They’re fortunate this option even exists.
The typical profile of a reverse mortgage customer is someone who needs more cash flow in the worst way, and they don’t want to move. For older Canadians in this boat, there are ways to mitigate borrowing costs while tapping equity, which include:
1. Applying for a HELOC instead
That assumes you can qualify for a home equity line of credit (HELOC), and most reverse mortgage customers can’t, especially with the stress test rate (the rate lenders make them prove they can afford) at around 8 per cent.
If you want to try your hand at a HELOC, look at Manulife’s Equity Advantage. It’s pretty much the most flexible reverse mortgage alternative of any HELOC. It’s easier to qualify for, in some cases; you generally don’t have to worry about making the minimum interest-only payment if you deposit your income into its built-in chequing account; and Manulife is not in the habit of freezing HELOCs on seniors who don’t default.
2. Choosing a shorter term, like a one-year fixed
There’s no payment risk of a shorter term because reverse mortgage borrowers don’t make payments. And over 10 years, a series of shorter terms will usually cost less than a five-year fixed – especially if rates are well above the five-year average, as they are today.
3. Drawing funds when needed, instead of borrowing one lump sum
This can slash the interest expense for your reverse mortgage dramatically.
4. Shopping for a better deal
Compare rates, fees, prepayment penalties and loan amounts at HomeEquity Bank, Equitable Bank, Fraction Mortgage and Bloom Finance.
Lenders are protecting themselves
High reverse mortgage rates are a problem for lenders too, especially when property values are plunging. Reason being, these two factors reduce the equity buffer the lender relies on. That buffer is essential to ensuring it gets all its money back when the reverse mortgage is paid off.
This is why all reverse mortgage lenders have been trimming the amount they’ll lend – relative to the home value. In many cases, “loan-to-values” as they’re called in the business, have been cut by more than six percentage points.
For a 67-year old homeowner, that might limit borrowing to 31 per cent of home value instead of 37 per cent, for example, or $30,000 less on a $500,000 property.
Long story short, the heyday of the reverse mortgage business is gone, at least until we see rates back below 5 per cent. And that could take a few years.
Five-year fixed rates hit a new 14-year high
Anxiety over reaccelerating inflation and central bank aggressiveness drove Canadian bond yields to new long-term highs this week. That’s never good news for fixed rates, which are partly derived from government yields.
In my weekly survey of national lenders, the average uninsured five-year fixed edged up three basis points this week, but there are many more hikes forthcoming.
Even variable-rate discounts from the prime rate (5.45 per cent) are shrinking. The big banks are now down to prime minus 0.35 per cent on an average discounted basis, from prime minus 1 per cent last fall. The main catalysts here are rising deposit costs, growing perceived credit risks and market liquidity pressures, all of which raise funding costs.
The moral: If you need any kind of mortgage rate lock for a closing in the next four months, apply this week.
Rates are as of Thursday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20-per-cent down payment, or those switching from a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.