"Homeowners over the age of 55… should consider all factors when contemplating how to fund their retirement spending"
This article was provided by Equitable Bank.
A reverse mortgage is a timeless financial tool that can be useful for many seniors who own their home. While it may not be the first option that comes to mind, it can be a viable strategy for homeowners even though interest rates have risen.
Many people’s first inclination is that this product is far too expensive to consider. Expensive is not an absolute concept – it is all relative. The cost of a reverse mortgage needs to be considered relative to the available alternatives.
A conventional mortgage or home equity line of credit tends to be at a lower interest rate than a reverse mortgage. But this is the case in part because of the income qualification requirements for these products, the regular monthly payments, and the government-backed mortgage default insurance that protects the lender from losses. None of these factors apply when a borrower obtains a reverse mortgage, so the interest rate cost tends to be higher as a result.
Retired homeowners may only qualify for a limited mortgage or home equity line of credit balance because they are no longer working. As a result, it may be a mistake to compare reverse mortgage rates to the discounted rates that a prime, middle-aged borrower with a good income may be able to secure. A reverse mortgage may be a senior’s primary or potentially even their only borrowing option beyond more expensive unsecured debts like credit cards.
Alternatives to borrowing can also be expensive. Downsizing a home incurs selling and repurchase costs. In Toronto, as an example, real estate commission to sell a property typically costs 5% plus an additional 13% HST. Provincial and municipal land transfer tax to purchase a $1 million property totals an additional 3.3%. After adding in moving costs, legal fees, and ancillary expenses, the all-in costs could total around 10% of a current home’s value for a downsize in Toronto. Many also find they cannot downsize and stay in the same community, from a house to a condo, for example, and be left with any material net proceeds after these expenses. Moving to another city or town is not always an enticing option.
Because a reverse mortgage borrower only pays interest on the funds they borrow, the dollar value of the interest cost relative to the value of their home – or the cost of selling that home – could be quite modest.
A senior with $100,000 of income receiving Old Age Security (OAS) pays a really high rate of tax. It can be more than a 50% marginal tax rate (including OAS recovery tax) in several provinces. So, while taking extra withdrawals from a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) to fund cash needs might seem like a way to alleviate a cash flow shortfall, it can leave an account holder with less than half of their withdrawal after tax is paid.
According to a recent study on savings and sources of income in retirement, 58% of Canadians expect their retirement income to come from government pension programs. Unfortunately, the OAS pension and Canada Pension Plan (CPP) retirement pension provide inadequate income for most retirees to fund their retirement expenses. If an OAS recipient has not lived in Canada for most of their adult life, they may not receive the maximum monthly payment of $686 (as of December 2022 for those under age 75). The 2022 CPP retirement pension maximum is much higher at $1,254 per month. However, most seniors receive nowhere near that much from CPP, given the average payment is just $738 per month (as of July 2022).
The rising cost of living is making it more challenging for seniors to cover their expenses. Energy and food costs have skyrocketed more than the general rate of inflation, rising 16.2% and 10.1% respectively for the year ending October 31, 2022. These expenses tend to represent a significant share of a senior’s spending.
Retirees living on fixed incomes or those whose investments have plummeted have seen their ability to maintain their cost of living seriously compromised with the spike in inflation.
Although real estate prices have also fallen in 2022, seniors who own their home and have no debt have likely seen many years of real estate price appreciation. A reverse mortgage is a method to access that home equity, in whatever increment is required, without the stress and cost of downsizing.
Selling and renting is an option as well, but also has its risks. Depending on the province and the lease agreement, tenants may need to vacate a property on relatively short notice if a landlord or family member moves into the property. This potential of having to move can also apply if a landlord sells a property or renovates it. So, the stress and risk of being a renter in retirement can also be significant and a reason to at least consider a reverse mortgage as an option for a senior to stay in their home.
Even wealthy homeowners in a high tax bracket should consider the potential tax savings from utilizing a reverse mortgage compared to paying a high tax rate on additional withdrawals from their investments.
So, is a traditional mortgage or line of credit a viable and potentially less costly alternative to a reverse mortgage? Yes, it certainly may be better for some who can take advantage. But given the impediments and frequent inability for seniors to qualify for traditional financing, a reverse mortgage may be a great alternative.
Homeowners over the age of 55 and those providing advice to them should consider all factors when contemplating how to fund their retirement spending in a personalized and practical fashion.
The key to assessing the relevance of a reverse mortgage is not based on the interest rate relative to the lowest mortgage rate available to a younger borrower. It should be premised on the cost of the interest compared to the alternatives. Furthermore, the financial implications of a reverse mortgage or another option available to a senior are just part of the assessment. The non-financial benefits to stay in their home and avoid the stress of moving are difficult to measure for a senior and potentially the family members who might need to be part of the moving process.