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What Is a Reverse Mortgage?
Exclusively designed for seniors or individuals aged 55 years and older who either already own their home or are close to paying off their mortgage, a reverse mortgage is a loan that allows homeowners to borrow money against the equity in their homes. In contrast to a conventional mortgage, a reverse mortgage does not require borrowers to make monthly payments. Rather, borrowers are only required to pay back their loan in full when they permanently move out or sell their home. Considered an innovative lending product, a reverse mortgage allows seniors and older homeowners to borrow up to 55 percent of the current value of their primary residence, while still retaining ownership and title of their home.
A reverse mortgage can be a valuable retirement planning solution for homeowners that have most of their net worth tied up in the equity in their home. It provides a source of tax-free income, while also allowing older homeowners to enjoy retirement in the comfort of their own home.
In this article, we’ll explore how reverse mortgages work, what lenders offer them, and why they are becoming an increasingly popular and important retirement planning solution for Canadians.
How Does a Reverse Mortgage Work?
While eligibility requirements for a reverse mortgage can range from lender to lender, there are basic requirements that borrowers must meet. In order to be approved and receive funding for a reverse mortgage in Canada, borrowers (and anyone else listed on a home’s title) must be at least 55 years of age, and they must own their home. The home must also be the borrowers’ primary residence—meaning that they live in the home for at least six months of the year. Although these are basic requirements for Canadian borrowers, lenders may have their own additional eligibility requirements, which may include a minimum appraisal value of a home. Before receiving funding, borrowers are also required to pay off and close any outstanding lines of credit or loans that are already secured by the home.
Borrowers that meet the eligibility requirements on a reverse mortgage will have the ability to borrow up to 55 percent of the home’s current value, and they will have several options for how they want to receive their funds.
Before we explore payment options, we’ll use an example to illustrate how the maximum amount homeowners can borrow on a reverse mortgage is calculated.
Meet Drew and Parker. Drew and Parker own a home together. Drew is 68, and Parker is 66. They’re both retired. They have completely paid off their original mortgage on a home they purchased for $150,000 in 2002. The home is still their primary residence, and it now has a current value of $900,000. They do not have sufficient retirement savings to maintain their current lifestyle, and a considerable amount of their net worth is tied to the equity in their home. Since they no longer have regular jobs, they would like to unlock some of the value in their home to supplement their current income. With the current value of their home, they could potentially borrow up to $495,000 with a reverse mortgage (55 percent of $900,000).
While 55 percent is the maximum amount homeowners can borrow on a reverse mortgage in Canada, there are other factors lenders will consider when determining each individual borrower’s maximum amount. The maximum amount homeowners can borrow depends on several factors, including the homeowner’s age, the appraised value of the home used to secure the loan, the property location, the type of home, and whether the home’s original mortgage has been completely paid off or is approaching maturity.
Reverse mortgage products can also differ from lender to lender, and some lenders may even offer multiple reverse mortgage products. So, the maximum amount a homeowner can borrow may depend on additional factors, including specific product details and unique lender requirements.
Although borrowers aren’t required to make any monthly payments on a reverse mortgage, they will want to consider how they would like to receive their reverse mortgage payments from their lender. They should also be aware of what options they have if they choose to repay their loan.
What Are the Payment Options and Repayment Options for Reverse Mortgages?
Once borrowers are approved for a reverse mortgage, they will typically choose between three different funding or payment options: a single lump sum payment, regular monthly or quarterly payments, or a unique combination of the two. Lenders may choose to offer these funding options through different reverse mortgage products, and those products could include differences in eligibility requirements, interest rates, and repayment options.
When it comes to reverse mortgages, borrowers do not have any restrictions on how they choose to use their funds. So, while a brand-new jet ski isn’t out of the question, there are some other particularly beneficial ways for borrowers to use their funds. Reverse mortgages are often used to pay off other debts, finance home renovation projects that can increase a home’s value, pay for medical expenses, or even access capital for other opportunities.
In recent years, the financial industry has even seen a growing trend of older homeowners using reverse mortgages to help their children or grandchildren with a down payment so they themselves can enter Canada’s competitive real estate market. That’s because the rapid increase in home prices in the early 2020s that drove up equity for older homeowners also had an inverse effect, pricing many younger potential homebuyers out of the market.
Although homeowners can use the funds any way they wish, reverse mortgages are still most often used to help seniors and older homeowners cover the increased cost of living by converting a home’s equity into a regular, tax-free income. When used as a supplemental source of income, a reverse mortgage can provide older homeowners with the opportunity to convert equity into cash without having to sell their home. Receiving payments that simulate regular income allows those homeowners to continue living in their home where they can enjoy retirement while remaining financially secure.
The mortgage must only be paid back when borrowers move out of the home, sell it, or the last borrower on the home’s title dies—in which case, the estate is responsible for repaying the amount owing. If the home is sold, borrowers move into permanent care, or borrowers die, there may be certain requirements for when the full amount must be paid back. The timeline for repaying a reverse mortgage in these circumstances can typically range from 180 days to a year, and most heirs will choose to repay the loan by selling the home.
For borrowers that choose to repay their reverse mortgage, repayment options are flexible. Borrowers can repay their interest and mortgage in full at any time, or they can also choose to pay just the interest or the interest and a portion of the principal. Some reverse mortgages even come without prepayment fees or penalties.
What’s the Difference between a Reverse Mortgage and a Home Equity Line of Credit (HELOC)?
While both a reverse mortgage and a home equity line of credit (HELOC) are lending products secured by a residential property, there are a few key differences between them. Where a reverse mortgage allows borrowers to accept a lump sum payment, regular payments, or a combination of the two, a HELOC offers borrowers a revolving line of credit that is often combined with the borrowers’ mortgage where funds can be withdrawn anytime.
With a reverse mortgage, borrowers are not required to make any payments until they permanently move out of the home, the home is sold, or the borrowers dies. Conversely, with a HELOC borrowers are required to make minimum monthly payments on the interest owing—an arrangement that is more like a credit card, line of credit, or a traditional loan.
Reverse mortgages belong to an innovative group of lending products known as real estate secured lending (RESL) products. In addition to reverse mortgages, RESL products also include home equity lines of credit (HELOC), combined loan plans (CLPs) that include a traditional amortizing mortgage blended with a revolving or non-amortizing home equity line of credit, and mortgages with shared equity features.
RESLs have unique risk management considerations for lenders, and in Canada they are subject to maximum loan-to-value (LTV) ratio limits.
Rising Costs of Living Will Continue to Drive Demand for Reverse Mortgages in Canada
While reverse mortgages were once considered a last resort for seniors and older homeowners, Canada’s housing boom that was triggered by the pandemic in the early 2020s has largely eroded some previous unfounded stigmas and misconceptions about this unique lending product and retirement planning solution. Among those misconceptions was the belief that at the end of a reverse mortgage, the lender would own the home. But that’s not the case.
During the pandemic a unique combination of factors, including near-zero interest rates, a short supply in the housing market, and skyrocketing home prices, drove up equity for many older homeowners. As home prices skyrocketed, so did demand for reverse mortgages. That was likely because the higher prices of homes across Canada meant that many older homeowners had significantly more room to borrow with a reverse mortgage, and the low interest rates made it an attractive option. In addition, many seniors faced concerns with safety and outbreaks in Canada’s long-term care homes.
Now, reverse mortgages are more popular than ever.
HomeEquity Bank, Canada’s largest and first reverse mortgage provider, reported over $1 billion in reverse mortgage originations in 2021. Equitable Bank, Canada’s only other provider of reverse mortgages as of 2022, experienced a similar spike as its reverse mortgage assets grew 262 percent year over year from 2021 to 2022.
As the Canadian housing market lost momentum and began a much-needed correction in 2022, record high home prices began to slip. By August 2022, inventories were climbing, prices were sliding, and sales had plummeted in major Canadian cities, contributing to the MLS Home Price Index falling 13 percent (or $178,000) to $1.16 million.
But despite falling home prices and rising interest rates, reverse mortgages are here to stay.
With limited income, the central bank hiking interest rates, and record high inflation continuing to drive up the cost of living in Canada, many older homeowners may be weighing other financial options to stabilize and supplement their income.
With these conditions affecting Canadians across the country, the demand for reverse mortgages is likely to continue to grow as more and more financial advisors and homeowners begin to consider reverse mortgages as a valuable tool in retirement planning.
Why Don’t More Banks Offer Reverse Mortgages?
Despite its ability to offer seniors and older homeowners access to untapped equity and supplemental tax-free income, reverse mortgages are still only offered by two Canadian federally regulated financial institutions: HomeEquity Bank and Equitable Bank.
That could soon change.
With home prices today accounting for a much larger chunk of an individual’s portfolio than it did in the past, reverse mortgages are becoming an increasingly important retirement planning solution for aging homeowners and their financial advisors.
If you’re a financial institution interested in providing reverse mortgages to Canada, contact Portfolio+ for information about our financial technology and mortgage software.
https://globalnews.ca/news/7602336/the-pandemic-housing-craze-is-fuelling-another-boom-reverse-mortgages/ (Retrieved August 11, 2022)
https://www.homeequitybank.ca/media/press-releases/homeequity-bank-surpasses-1-billion-in-reverse-mortgage-originations-during-2021 (Retrieved August 9)
https://financialpost.com/fp-finance/banking/equitable-posts-best-earnings-ever-as-mortgage-business-stays-strong (Retrieved August 12)
https://www.canada.ca/en/financial-consumer-agency/services/mortgages/reverse-mortgages.html (Retrieved August 10)
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