An option that allows seniors to age in place that seems too good to be true is a reverse mortgage.
Definition of a Reverse Mortgage: a loan that allows homeowners to borrow against the value of their home. The amount borrowed is calculated based on the value of the home, age of the homeowners and specific lender.
Reverse mortgages advertise their benefits on various media platforms like T.V. and radio. The ads usually show a happy couple who chooses to stay in their home; only possible because of a reverse mortgage. The ad usually compares a reverse mortgage to a home equity line of credit (HELOC).
Definition of a HELOC: a line of credit that is secured by the value of the borrower’s home. HELOC’s are revolving credits that allow the borrower to borrow money, pay it back, and borrow again up to a certain limit.
REVERSE MORTGAGE vs. HELOC
|How You Obtain Funds||Monthly payments, lump-sum payments, line of credit or some combination of these.||On an as-need basis, up to a pre-approved credit limit.|
|Repayment Schedule||Deferred repayments with the loan due as soon as the borrower sells the home or passes away.||Monthly payments based on the amount borrowed and the current interest rate.|
|Age and Equity Requirements||Must be at least 55 or older and own the home outright or have a small mortgage balance.||No age requirement and must have at least 20 per cent equity in the home.|
|Credit and Income Status||No income requirements; however, some lenders may check to see if you are capable of making timely and full payments for ongoing property charges.||Good credit score and proof of steady income sufficient to meet all financial obligations.|
|Tax Advantages||None until the loan terminates; then it depends.||Same as for a home-equity loan.|
As the old saying goes: “if it seems too good to be true, it probably is.” Some of the disadvantages of a reverse mortgage are:
- The interest rate is much higher than a typical mortgage rate;
- The more equity the homeowner borrows the interest starts to accumulate more rapidly;
- There are additional startup costs that can add up that is deducted from the amount the homeowner will receive;
- The only way a homeowner can get out of a reverse mortgage is to either sell their home or pass away;
- There are penalties if the homeowner sells their home or passes away within three years of taking out the reverse mortgage;
- If the homeowner passes away, the amount borrowed plus the interest must be paid within a limited period, and;
- If the homeowner passes away, the homeowner’s children or other heirs will be left with less since the reverse mortgage lender needs to be paid first.
If the disadvantages of a reverse mortgage outweigh the advantages, there are other options to consider:
- Apply for a Home Equity Line of Credit (HELOC) that allows a homeowner to access up to 65 per cent of the equity in the home and still maintain ownership of the property.
- Create rental income by renting a portion of the home.
- Sell, downsize and reinvest.
RAHB recommends that you seek legal advice before applying for any line of credit.