Many cash-strapped British Columbians have a mountain of equity in their home. Older homeowners can sometimes find themselves rich in home equity but cash-poor. If selling your home isn’t an option you may be considering a reverse mortgage. Finding out how they work can help you decide if this is the right product for you.
Accessing the Equity in Your Home
There are several ways you can access the equity in your home. You can:
- Sell your house.
- Refinance your mortgage or your home.
- Set up a Home Equity Line of Credit.
- Get a reverse mortgage.
Refinancing your home or setting up a line of credit will generate payments you need to make, usually on a monthly basis. Reverse mortgages allow you to use the equity in your house without making payments.
So, what are reverse mortgages, and how do they work? When you take out a mortgage, the financial institution pays the seller when you buy a home. You repay the lender until the mortgage is paid off. A reverse mortgage, on the other hand, advances the money to you. It can be in a lump sum, a partial lump sum, or a series of payments.
There are several things you need to know about getting a reverse mortgage:
- All homeowners on the title must be 55 years old or older.
- You need to apply to get a loan approval.
- You can calculate a reverse mortgage amount that you could qualify for by using an online reverse mortgage calculator.
- You and any other owners may be required to get Independent Legal Advice before the transaction can take place.
- There are typically set-up fees like legal fees and appraisal fees.
- You can borrow up to 55% of the equity in your home if you qualify.
- You must live in the home for at least six months a year.
- The loan is fully payable (due) when the last person on the title passes away or moves out, you sell the house or violate the terms of the agreement.
Is a reverse mortgage a good idea?
If you have a lot of equity in your home but need more cash resources, a reverse mortgage can help you by putting money in your pocket. You can use the money for almost anything, including:
- Bill payments.
- Provide debt relief.
- Paying for renovations so you stay in your home.
- Medical care.
- Pay off your existing mortgage and eliminate monthly payments.
Another valuable feature is that no payments are required. If you’re on a fixed income and your costs are going up, not having to make mortgage payments every month can make it much easier to stay within your budget. Many reverse mortgages offer the option of making interest payments, principal payments, or both. However, some will charge you fees to do so.
One of the most significant benefits is that you don’t have to move. You might love your home and want to stay there but lack the money to realize that goal. A reverse mortgage can make it possible for you to keep your house.
What are the disadvantages of a reverse mortgage?
As with any financial product, there are things to be aware of before you decide to get a reverse mortgage. Once you consider the impact it can have on your finances and home equity, you may decide there are better options available to help you achieve what you want.
First, you need enough equity in your home to qualify. If you have recently purchased your home with a minimal down payment or refinanced your mortgage, you might not have the necessary equity to get a reverse mortgage.
The costs are another factor to consider. There are set-up fees, and although you don’t have to make payments, interest is still charged on the amount you borrow. If you hold the mortgage for years, you could owe a staggering amount of interest. The high interest costs can significantly reduce your equity when you sell your home or pass away.
Finally, you are still responsible for paying the taxes and maintaining the upkeep of your home. If this is not affordable, a reverse mortgage will add to your household debt and put you in a more difficult situation.
How does interest work?
Payments are only required once the loan is due, but interest is still charged. Interest rates can be fixed or variable. A fixed rate of interest means that the interest rate is set for a term such as five years and won’t change for the entire term.
A variable interest rate will change as the prime rate changes. A variable rate will increase if the prime rate increases, so your interest charges will be higher. If the prime rate decreases, your interest rate will decrease, so your interest charges will be less.
Variable rate mortgages are similar but not the same as an ARM mortgage ( adjustable rate mortgage). If you have a mortgage where you have to make payments (conventional mortgage) and your rate is variable, your interest rate may change, but your payment will not.
A decrease in your variable rate can result in you paying off your mortgage faster because more of your payment will go to your principal and less to interest. An increase in your variable rate will have the opposite effect. It will extend the time it will take you to pay off your mortgage because more of your payment is going to interest and less to principal.
An ARM mortgage (adjustable rate mortgage) will change your payment as the rate changes to keep you paying off your mortgage on the same schedule. Your payment will decrease if the rate decreases and increase as the rate increases. Since reverse mortgages do not require payments, you can have a variable rate mortgage but not an ARM.
Interest rates on reverse mortgages are typically higher than rates for conventional mortgages or Home Equity Lines of Credit. You could owe a substantial amount when your loan is due because of the interest costs.
The amount you owe when you must pay off the loan may not be a concern if your home has increased in value. If your house hasn’t appreciated, you cannot owe more than the fair market value of your home. So, the worst that can happen is that you’ll have no equity remaining when the loan is due.
Alternatives to a Reverse Mortgage
Like most financial products, a reverse mortgage can be a valuable part of your retirement planning process or harm you financially. It’s essential to understand the product and your obligations thoroughly.
Alternative debt relief options can allow you to do that without using the equity in your home. You could consider consolidating your debt with a personal loan or line of credit. If you have a large amount of debt or won’t qualify for a debt consolidation loan, you may benefit from the services of a Licensed Insolvency Trustee (LIT).
LITs offer credit counselling and government-approved debt relief programs to help you eliminate your debt, keep your assets and stay in your home. At Allan Mashall and Associates, we will work with you to find the best solution for your debts. Contact us by filling out the online form, by email or by calling us at 1-888-371-8900 for a free, no-obligation consultation so you can get the correct information to make the best decision for your circumstances.