Should You Get a Reverse Mortgage?

A reverse mortgage is a loan against your home where you don’t have to make mortgage payments.  The lender gives you a lump sum or regular payments that are limited to a percentage of your home’s value, typically 20-60% depending on your age, and you get to stay in your home.  The mortgage balance grows until you die, leave your home for some other reason, or choose to pay it off.

In a typical case, you or your estate pays back the lender from the proceeds of selling your home.  For most reverse mortgages, you get to stay in your home even if the debt grows to more than the home’s value.  The best information I could find is that this happens less than 1% of the time, which is hardly surprising given the extended real estate boom in Canada. House prices have been appreciating fast enough to keep ahead of the debt.

The number of reverse mortgages held by Canadians is still just a tiny fraction of all mortgages, and even fewer reverse mortgages have run to completion.  It’s hard to say much about whether they have worked out well for Canadians based on the experience so far.

Your home as a financial backstop

Many people think of a reverse mortgage as a last resort if they’re running out of money in retirement.  If you have no other access to enough assets or income to stay in your home, a reverse mortgage can be a solution.  This is often the way financial advisors position reverse mortgages in financial plans. 

However, staying in your home isn’t always the best plan.  Every situation is different.  Good reasons to stay in your home are that you can still handle the work required and you have activities, friends, and family nearby.  A poor reason I’ve seen come up frequently is the fear of dealing with a lifetime of accumulated junk.  The older people get, the more they find the thought of moving overwhelming.

Instead of staying in your home, you could move to a smaller home, but transaction costs eat into the amount of extra cash you end up with.  Other alternatives are to rent a home or live together with someone else.  At least consider these ideas before reflexively deciding to stay put alone.  Your home can still serve as a backstop for your financial plan even if you don’t end up getting a reverse mortgage.

If you do get a reverse mortgage when you’re running out of money, the best uses for the new money are daily living, necessary repairs, and paying property taxes and insurance.  It rarely makes sense to use a reverse mortgage for elaborate vacations, large family gifts, big home renovations, or other largesse.  However, renovations aimed at making the home safer for elderly owners could be an exception.

The potential downsides of reverse mortgages

The mortgage rates on reverse mortgages tend to be high, because the lender faces a lot of uncertainty about when they’ll get their money back.  There are also fees and prepayment penalties, so it can be expensive to get out of a reverse mortgage if you change your mind.

Another downside is the possibility of the lender forcing you out of your home if you fail to pay your property taxes or insurance, or if you fail to maintain your home adequately.  Anything you neglect that could seriously undermine your home’s resale value could be grounds for forcing you out.  Think of your elderly neighbours with falling-down fences and decks, green swimming pools, and pets using the whole house as a litter box.

The lender has little incentive to force you to leave as long as you owe less than your home is worth.  With this happening less than 1% of the time currently, we don’t have much of a handle on how hard it is for a lender to force you out.

Currently, lenders hoping to grow their reverse mortgage businesses have little incentive to create bad press by pushing elderly people to the curb.  So, recent experience tells us little about what could happen in the future.

If the current drop in house prices or any future drop pushes many reverse mortgages underwater (where people owe more than their homes are worth), we may get to find out how lenders and the courts will react.  A lender may choose to sell its book of underwater reverse mortgages to another lender that is less concerned about its public image and more willing to evict people.  

Conclusion

A reverse mortgage can be a good financial backstop for your retirement in case you run out of money.  Knowing it’s a possible last resort, you can confidently plan to enjoy spending the money you saved up for retirement.  However, keep in mind that as you age, home maintenance gets harder, particularly if money is tight.  If at some point you aren’t maintaining your home or are failing to pay property taxes or home insurance premiums, you may have to leave your home.