Are reverse mortgages worth the extra costs?

A reverse mortgage allows you to pull money from the equity of your home without having to sell it or make payments.

To be eligible, you must own a primary residence and be at least 55 years old.

The amount you can borrow is determined by your age — the younger you are, the less you can borrow. For example, 55 to 60 year-olds can only borrow up to 15 per cent of the value of their home, whereas someone who is in their 80s can borrow up to 55 per cent.

Cash-flow poor, asset rich

The typical reverse mortgage client is in their 70s. They are cash-flow poor, but asset rich.

With respect to costs, you can expect to pay $1,800 to $2,300 for legal and administration fees, $300 to $400 for an appraisal, and another $300 to $500 for independent legal advice if your lender requires it.

The current rate for a variable five-year term is 6.24 per cent and 6.74 per cent for a fixed-term mortgage.

The rates are approximately three per cent more than conventional mortgages because the lender is providing the fund upfront — foregoing scheduled payments — and won't get repaid until the borrowers die or the house is sold, which could take decades.

Borrowers need to be aware of the dangers of compound interest, which is great when saving, but costly when borrowing.

Since the borrower is not making regular payments, they end up paying interest on their interest. Borrowing $100,000 for 10 years would have an estimated total interest cost of $89,000.  

Most people who make use of reverse mortgages typically have cash flow problems so it is unlikely they will be able to repay the mortgage early.

However, keep in mind that if you are suddenly able to pay down the loan, for example because of an unexpected inheritance, you could be subject to a pre-payment penalty of up to five per cent. This penalty reduces over time and usually disappears after five years.

If a married homeowner dies, the contract remains in force until the other spouse dies. If the homeowners end up moving to a care home, the pre-payment penalty is reduced by 50 per cent.

You cannot keep the home, maintain the reverse mortgage, and live at a care home all at the same time.

Down to the math

There are reasons to consider reverse mortgages, such as you receive tax-free money which will not reduce your income-tested government benefits like Old Age Security or Guaranteed Income Supplement, or your home's appreciation might offset some, if not all, of the interest charged.

Some retirees in their late fifties or early sixties take out a small lump-sum reverse mortgage in order to delay enrolling in the Canada Pension Plan (CPP) or Old Age Security (OAS).  

If you delay CPP until age 70, the benefits received would be about 142 per cent of what they would be at age 65. This tactic could make sense if longevity runs in the family.

At then end of the day, it comes down to the math.  

You need to weigh the pros and cons of a reverse mortgage versus a conventional mortgage versus selling your home and then decide what is best for you.

If you are leaning towards taking out a mortgage, deal with a broker who offers both conventional and reverse mortgages. This way you are more likely to get an unbiased opinion.  

This column is part of CBC's Opinion section. For more information about this section, please read this editor's blog and our FAQ.