Reverse mortgages can be a fantastic solution for Canadians age 55+ who want to improve their retirement but they aren’t the only option.
If a reverse mortgage does not align with your goals, there are 3 different alternatives to consider. A Home Equity Line of Credit, regular mortgage, or sell and downsize.
1. A HELOC (home equity line of credit) is a product that many of us are familiar with and it’s usually the first thing people think about when they need a flexible product. And a HELOC is just that; flexible. It is secured against your home just like any mortgage but in this case, the product is ‘revolving’. This means that you can borrow against your home as often as you like, up to the approved limit. And like a credit card, you are only obligated to make minimum interest payments each month. The line of credit is also fully ‘open’, meaning that you can pay back the entire balance whenever you like and without penalty.
The challenge with HELOC’s today is that they are difficult to qualify for based on today’s mortgage rules. Banks are obligated to review your income and ensure that you could still make monthly payments if you advanced the entire limit. In addition, you must qualify on the stress test which is 2% higher than the actual HELOC rate. For example, if the rate based on prime today is 4.25%, the bank needs to prove that your income could support a rate increase to 6.25%.
The other issue with HELOC’s is that the required interest only payment increases as the balances grows. Since the line of credit is based on prime lending rate, you are also susceptible to rising interest rates. It can get to a point where you are now financially stressed and unable to reduce the balance in a meaningful way. If this happens and you are late on payments or miss a couple, the bank can and will ‘call’ the loan. You will have to find a way to payback the loan in full lor be forced to sell.
2. Conventional or regular mortgages offered by dozens of financial institutions are also another option to consider before applying for a reverse mortgage. Like HELOC’s, interest rates on regular mortgages are lower than reverse mortgages. The overall cost of borrowing or interest charged will be smaller due to the reduced rates and also due to the fact that you are required to make monthly interest and principal payments. This type of mortgage is beneficial if you are not worried about cash flow and can easily service the debt.
Though regular mortgages can offer more security than HELOC’s, the flexibility is limited. Pre-payments are typically capped to around 15% of the original mortgage balance each year without penalty. If you wish to pay more than 15%, a penalty will be incurred. Also, if you decide to sell or wish to payoff the mortgage early with your own savings or investments, a penalty will be triggered. The penalty charge will depend on the type and length of term you selected.
Qualifying for a normal bank mortgage is also difficult today. Just like HELOC’s, the mortgage application must be stress tested at 2% higher than your actual mortgage rate. As this article is being written, the average 5 year fixed term is around 3.59%; when stress tested, your income must support a payment based on a hypothetical rate of 5.59%. The stress test decreases the amount you could otherwise borrow by up to 20%.
3. Downsizing can also be a great solution if this is what you want. Choosing to downsize and being forced to downsize are two very different outcomes. Selling your home and using the funds from the sale to payoff your mortgage and/or other debts can certainly reduce stress and help improve your retirement lifestyle. Even better, if there is money left over to put into the bank. The majority of Canadians, however, do not want to downsize.
The statistics vary slightly but on average 80% of homeowners age 55+ want to remain in their home. Being forced to sell or downsize for financial reasons is the option of last resort. Reverse mortgages, home equity lines of credit, and regular mortgages are all products to consider before feeling the need to sell your home.