Take a well-discounted five-year fixed mortgage rate and double it. Now you have the cost of a reverse mortgage, the great problem-solver for seniors with money issues.
Reverse mortgages let you siphon equity out of your home in retirement without paying any interest until you sell. The catch: The five-year fixed reverse mortgage rate was 5.59 per cent this week for HomeEquity Bank’s CHIP Reverse Mortgage and 5.49 per cent for the Equitable Bank Reverse Mortgage.
Historically speaking, these rates don’t seem that high. But it’s been more than 10 years since anyone paid 5 per cent or more for a properly discounted traditional mortgage. Today, a cheap five-year fixed mortgage might go for 2.69 per cent.
Financial planner Rob Montague got a first-hand view of reverse mortgages not too long ago when he helped a widowed, 80-year-old family member set up a $250,000 loan. “My beef with the reverse mortgage is the rate,” he wrote in an e-mail. “I believe it is predatory.”
The interest rate on the HomeEquity reverse mortgage Mr. Montague was talking about came in at 5.99 per cent – a cut to 5.59 per cent happened afterwards. HomeEquity Bank, by far the largest of the two reverse mortgage providers in Canada, offers a calculator on its website that pegs the interest cost of the $250,000 reverse mortgage at $15,199 after one year, $85,815 after five years and $206,593 after 10 years. HomeEquity says the average term for its reverse mortgages is nine to 12 years.
With a traditional mortgage, the lender advances the money and immediately starts receiving blended payments of interest and principal from the borrower. Rates are higher on reverse mortgages because principal and interest aren’t repaid until the sale of a home, the timing of which is up to the owner. Reverse mortgage rates also reflect the risk that a home loses value between the time the mortgage is arranged and the sale later on.
These factors produce a rate calculation that HomeEquity Bank CEO Steve Ranson describes as follows: Take the rate that the bank offers on the guaranteed investment certificates it issues to fund mortgages and add 3.25 percentage points or so. “There’s no more science to it than that,” Mr. Ranson said.
The reverse mortgage business would have flopped if it weren’t for the strength in home prices we’ve seen for most of the past 20 years. Steadily rising prices help to offset the erosion of equity caused by comparatively high borrowing costs.
With zero price appreciation over 10 years, the HomeEquity calculator says there would be just $43,407 of equity left in the $500,000 home that produced the $250,000 reverse mortgage at 5.99 per cent. But if the home appreciated by 2 per cent a year, roughly in line with inflation, the remaining equity would be $152,904.
Toronto residents may scoff at a mere 2 per cent, but the city’s real estate market has seen hard times in the past. Canadian Real Estate Association numbers show the average resale home price in the city fell four straight years in the early 1990s and took 13 years to surpass its 1989 high.
The HomeEquity calculator doesn’t even allow a declining price to be used. Worst case, a reverse mortgage-customer whose house lost value walks away with zero equity after selling a home and owes nothing to the mortgage provider. Also, HomeEquity cannot force a reverse mortgage holder to sell in a declining market.
In an era of ridiculously low interest rates, reverse mortgage costs stand out as an exception. Why do people use them? Because they need money and the most practical way to get it is to tap into their home equity.
Mr. Montague described the reverse mortgage used by his family member as a last resort. This person had a maxed-out $75,000 line of credit and a low income based mainly on Canada Pension Plan, Old Age Security and Guaranteed Income Supplement payments.
Also, she was adamant about staying in the home she’d occupied since 1976, rather than selling and moving to a retirement community. In Mr. Montague’s words, “the reverse mortgage was the only option available to keep her in her home.”
Reverse mortgages are a problem-solver for cash-poor, house-rich seniors, but they cost a lot. Ask yourself how much equity you’ll likely have at the end, and whether that’s enough to cover needs like long-term care. The cost of long-term care? Oh, about $1,000 to $3,000 or so per month.
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Rob Carrick