For most people, their largest asset is the equity in their principal residence. This is generally considered a lifestyle asset, not an income producing asset. If you are at least age 55 (Canada) or age 62 (USA) and want to continue to live in your own home, a reverse mortgage can create income for your retirement by giving you a way to access part of the equity in your home without having to sell or move.
1. What is a reverse mortgage?
A reverse mortgage (also known as a Home Equity Conversion Mortgage (HECM)) allows seniors who own their homes to tap into their home equity for money to use for other purposes. To qualify, you must either own your home or have only a small mortgage that can then be paid off with the funds from the reverse mortgage.
The homeowner can choose to receive the reverse mortgage funds as a lump sum, a line of credit, or a series of monthly payments. The loan amount, interest rate, and fees are determined by factors such as the age of the borrower, the value of the home, and the lender.
The loan does not have to be repaid until the homeowner dies, sells the house, or moves out permanently. However, the homeowner is still responsible for paying the property taxes, insurance, and maintenance costs on the home.
2. What are the eligibility criteria and legal requirements?
Not every homeowner is eligible for a reverse mortgage. Just like with traditional mortgages, you must meet the lender’s criteria as well as other factors. The eligibility criteria are slightly different between the United States and Canada.
United States
Eligibility criteria for a reverse mortgage in the U.S. include:
- You must be at least 62 years of age and live in the home as your primary residence.
- You must own your home outright or have a low mortgage balance that can be paid off with the proceeds of the reverse mortgage.
- The homeowner must complete a government-approved counseling program.
- There must be no late payments in the past 24 months for mortgage payments, property tax bills, insurance premiums or other property-related expenses.
- The reverse mortgage does not require credit score or income requirements, however, the lender will review your credit history.
Reverse mortgages are regulated by the U.S. Department of Housing and Urban Development (HUD) and insured by the Federal Housing Administration (FHA). The homeowner can receive the loan proceeds as a lump sum, a monthly payment, a line of credit, or a combination of these options.
The loan becomes due when you sell the home, move out, or die. The home is then sold to repay the mortgage loan, and any remaining equity goes to you or your beneficiaries.
Canada
NOTE: This financial instrument is not available in the Territories in Canada.
Canadian homeowners must meet the following criteria in order to qualify for a reverse mortgage:
- They must be at least 55 years old and live in the home as their primary residence.
- They must own the home outright or have a low mortgage balance that can be paid off with the proceeds of the reverse mortgage.
- The home must be a single family home, townhouse, condominium or duplex that is located in an urban area and meets certain standards.
- The homeowner must obtain independent legal advice from a lawyer and receive mandatory counseling from an approved agency before signing the mortgage document.
- There must not be any outstanding taxes, liens or judgments on the property.
Reverse mortgages are subject to the same legal requirements as regular mortgages and must be registered on title and take priority over other liens and encumbrances.
The loan amount cannot exceed 55% of the home’s appraised value. It is also subject to a maximum limit which varies according to province and lender.
A reverse mortgage can be repaid at any time without a prepayment penalty, unless the contract specifically provides for a penalty. The homeowner has the option to make payments at any time or defer repayment until the end of the term. The loan balance must be repaid (together with interest and fees) at the maturity date or when the homeowner sells, moves or dies. In the latter case, the homeowner’s estate and heirs are responsible for repayment.
3. What are the pros and cons of a reverse mortgage?
Pros / Benefits:
- You do not have to make mortgage payments.
- You do not have to have a credit check or verify your income.
- You can stay in your home and maintain ownership of it, so long as you continue to pay the property taxes, insurance, and maintenance costs.
- It may offer some protection from falling house prices, as the loan amount is capped at the appraised value of the home at the time of the loan.
- The loan proceeds are generally not considered taxable income and will not affect your eligibility for government benefits.
Cons / Downsides:
- A reverse mortgage can reduce the equity in the home and the inheritance for your beneficiaries, as the loan amount and the interest will accrue over time and are deducted from the sale proceeds of the home.
- The interest rates are typically higher than conventional mortgages or home equity lines of credit, and there may be additional fees which will be added to the loan balance and accrue over time.
- It may limit your access to other financing options, such as a home equity line of credit, and you probably will not be able to refinance, sell or move out of the home until you have repaid the loan.
- It may affect your eligibility for certain government programs or subsidies which require a certain level of equity in the home.
- It can expose the homeowner to certain risks, such as rising interest rates, changes in the terms and conditions of the loan, or fraud and scams by unscrupulous lenders or brokers.
- You will be required to maintain the property in good condition, pay property taxes and insurance, and comply with other obligations determined by the lender, or face default and foreclosure.
4. Takeaways
A reverse mortgage lets you keep the title to your home while you access your equity. As opposed to a traditional mortgage, you don’t make monthly mortgage payments toward a reverse mortgage. However, interest and fees are usually higher and are added to the loan balance every month, which lowers the amount of your equity in your home.
The answer to whether you should consider a reverse mortgage depends on your personal situation and goals. You should weigh the benefits and risks carefully and compare them with other options such as downsizing, renting, or using a home equity loan or line of credit, or a cash-out refinance loan to access your equity.
You should also seek independent advice from a reputable lender, a financial planner, and a lawyer before signing any contract. A reverse mortgage may be a good option for some retirees, but it is not for everyone.
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