Reverse mortgages are growing in popularity in Canada.
For Canadian seniors who own a home, reverse mortgages are a way to access cash without having to sell. Homeowners borrow against their home equity and receive cash right away, in a series of installments or a combination of the two.
The loan, available only to Canadians 55 and older, is repaid with the proceeds of the sale of the home. The bank waits to collect until the borrower either sells the home or passes away. Other events, such as the home burning down, can trigger repayment.
Just like a home equity line of credit or traditional mortgage, a reverse mortgage is a loan secured by the value of the property. However unlike those two traditional products, there is no minimum income requirement.
“With [a reverse mortgage], you stay in the home you love and access the equity from your home to live retirement your way,” said Steven Ranson, president and CEO of HomeEquity Bank, quoted in a marketing brochure for reverse mortgages.
But according to John Stapleton, a policy consultant, choosing a reverse mortgage is almost always a bad financial decision.
“The product is marketed at people who don’t have a baseline level of financial sophistication. Those who do will instead get a home equity line of credit, manage their affairs and make the monthly payments,” Stapleton said.
Gift to their kids
The popularity of reverse mortgages in Canada is growing, but most Canadians still haven’t heard of this product, says Shokhrukh Temurov, a vice-president at Morningstar DBRS, a credit rating agency.
In a report, Morningstar estimated the value of Canada’s reverse mortgage market in 2022 was $6.5 billion. Based on recently available figures, Morningstar estimates the value of the market in 2023 is $8.5 billion.
“I think most people are getting this product as a way to pass the proceeds as a gift to their kids who maybe need money to buy their own property,” Temuorov said.
The federal government has outlined the pros and cons of reverse mortgages in Canada. Pros include getting cash right away, the money is not taxable and it doesn’t affect the amount of Old Age Security or Guaranteed Income Supplement a homeowner receives.
The most significant con is the interest rate for a reverse mortgage in Canada is likely higher than the rate for a home equity line of credit.
The largest provider of reverse mortgages in Canada is HomeEquity Bank, which made up about 90 per cent of the market in 2023, according to Morningstar DBRS.
According to rates.ca, a website that tracks loan rates in Canada, HomeEquity Bank offers between 5.49 per cent and 9.4 per cent for a reverse mortgage, depending on the term of the loan.
In a reverse mortgage the borrower does not pay down the loan and may continue to add to the loan balance. The interest therefore compounds and can grow the loan balance significantly over time.
HomeEquity Bank provides an example in their marketing brochure for the product. With a home worth $800,000 today, the borrower takes out a $206,500 loan as a lump sum at a fixed interest rate of 7.39 per cent for 10 years.
With no monthly payments to make — in contrast to a traditional mortgage — the interest compounds with each passing year and the loan balance continues to grow.
If the borrower sold their home 10 years later, the amount owing would be the initial $206,500 borrowed plus $230,553 in interest.
HomeEquity Bank also illustrates a different structure. Here a borrower receives $20,000 upfront at the 7.39 per interest rate. Then the borrower receives monthly payments of $1,600 at a 9.40 per cent interest rate for the next 10 years. In this example the amount owing after 10 years would be $146,164 in interest on the same total of $206,500 principal borrowed.
Paper rich
Around 85 per cent of reverse mortgages in Canada were approved on properties in the Greater Toronto and Greater Vancouver areas, Morningstar DBRS says in its report.
The rapid spike in real estate prices in these areas makes recently approved reverse mortgages more risky for the banks. In the event of a severe real estate market downturn where housing prices fall dramatically, the proceeds from the sale of the home might not be enough to pay back the principal and accrued interest.
For that reason, lenders are “very conservative” when considering the value of someone’s property, Temurov says. At HomeEquity Bank, a customer can obtain a loan worth only up to 55 per cent of the value of their property.
The banks first require a third-party appraisal of your home. Then they make some discounts. The initial appraisal could be discounted anywhere from five to 30 per cent, depending on factors such as the type of property and its location.
Reverse mortgages are an option marketed to people who are “paper rich but cash poor,” Stapleton says. In other words, individuals who own a valuable home but have little or no income.
He says it may be a stress-free decision for someone who doesn’t want to move under any circumstances or manage the monthly payments of a different loan.
But he thinks a reverse mortgage is a bad idea. He thinks those who are able should look to “take out a line of credit if you need money for necessities.”
