Reverse mortgage is an innovative mortgage loan product designed for Canadian aged 55 and over. As more and more Canadians reach retirement, reverse mortgages continue to grow in popularity.
In a traditional mortgage, homebuyers pay a percentage of the cost of the home they are buying as a down payment, and borrow the rest of the money from a financial institution. They then pay back the money they have borrowed with monthly installments, as agreed upon with the lender. With each payment the homeowner makes, the balance of the mortgage decreases and the equity of the homeowner increases.
In reverse mortgages, homeowners already own their house, or a significant portion of their house. Based on the value of the property, the lender gives cash to the homeowners, either in a lump some or in scheduled deposits. In this circumstance, the balance of the mortgage increases as the homeowner receives payments, and their equity decreases.
Important things to know about reverse mortgages
The structure of a reverse mortgage is completely different from a traditional mortgage. In a reverse mortgage, the homeowner does not have to make payments, as they are on the receiving end of payments from the bank. They do, however, give up their equity in order to receive the money. Homeowners with reverse mortgages are still responsible for property taxes and house insurance.
Compared to traditional mortgage interest rates in Canada, the interest rates on reverse mortgages are significantly higher. For example, HomeEquity Bank – which offers the CHIP home income plan – charges a 5.9 interest rate on a fixed five-year reverse mortgage. In contrast, for traditional five-year fixed rate mortgages, they charge rates as low as 3.5 percent. This makes the loan grow quite quickly, as the entire reverse mortgage process is one of negative amortization – you never make payments toward decreasing the loan, so the balance continues to increase.
Currently, there are two ways to exit a reverse mortgage. The homeowner can sell the house and pay the principal and interest back to the lender or, upon the homeowner’s death, their estate repays the principal and interest. This means that the bank is paid first and if there is any money left, then the beneficiaries receive it.
If you choose to pay back your reverse mortgage before the term is over, you could face heavy penalties. The penalty ranges from 11 months of interest in the first year, dropping to four months of interest in the third year. The penalty is waived, however, if the repayment is due to the death of the homeowner and is decreased if the repayment is due to the homeowner moving into an assisted care facility.
Advantages to reverse mortgages
The biggest advantage to reverse mortgages is that there is no principal payment, making it attractive to senior citizens who do not have a lot of money but do have a large house or property. Additionally, the maximum the borrower will have to pay back is the value of their home, meaning they will not need to default or spend all their savings to repay the loan. HomeEquity Bank, for example, only lends up to 40 percent of the home’s current market value. After reverse mortgaging their home, most homeowners usually stay in their home for eight-to-12 more years. Coupled with the rising housing prices, this means that the sale proceeds of the home are usually enough to cover the outstanding loan balance from the reverse mortgage.
Borrowers can also choose to pay off their interest annually, which qualifies them for a half-point reduction of their interest rate in the following year. Most homeowners with a reverse mortgage do not use this option, however, as the program is designed for people who cannot make the interest payments.
Additionally, the money received from the bank as part of the reverse mortgage process is completely tax-free.