A reverse mortgage is a pretty neat idea but...

Seniors must contend with constantly eroding equity in their home using a reverse mortgage

Maroney on Money for November 8, 1998

It was way back in 1987 when the Canada’s first reverse mortgage hit the scene. Targeted to asset rich, cash poor senior citizens, a reverse mortgage allows qualifying homeowners to receive some of the equity in their home tax-free without selling or moving.

While the equity is received tax free the recipient is obligated to allow the provider to place a mortgage on their property. No payments are required during the period the mortgage is outstanding; interest simply accrues on an ever increasing balance. The mortgage becomes due and payable on the death of the homeowner (or last survivor) or upon sale of the home.

A reverse mortgage is a pretty neat idea but seniors must contend with constantly eroding equity in their home – hardly a source of great comfort. This situation is exacerbated in today’s comparatively soft real estate market where falling prices and compounding interest conspire to wipe out the reverse mortgage participant’s home equity.

But there is an alternative that essentially allows you to have your cake and eat it too. The program, known as the Life Estates Program, provides seniors with two benefits:

1. A lump-sum cash payment or a monthly income, through an annuity, that is both tax-free and interest-free, and

2. A commitment from the program provider to purchase their property at a predetermined appreciated value at the time of their death.

That’s right – there’s a company out there that is not only prepared to give you some tax-free money today but they’re also prepared to guarantee appreciation on your home and buy it from your estate when you die. It may sound like another “scam the seniors” routine but rest assured it’s not.

To participate in the Life Estates Program you must be a senior aged 65 to 80 and own a condominium or towhouse in a selected area of Greater Vancouver and Victoria. Unfortunately, selected areas currently include New Westminster, Burnaby, White Rock and Vancouver including both West and North Vancouver. At present Maple Ridge and Pitt Meadows are not included although, they likely will be in the future.

Upon acceptance into the program, Life Estates will advance to participants up to 20% of the appraised value of the property. Participants can choose to take a tax-free lump-sum payment or an annuity that will provide a monthly income for life. In the case of the annuity option, the payments received will be a blend of both principal and interest – the principal portion of each annuity payment will be tax-free, however, the interest portion will be taxable in the same manner as regular interest.

In determining the value of the subject property, approved participants are given the opportunity to choose two property appraisers from a list of certified appraisal companies. The average of the two appraisals is then used as the basis for calculating the amount of money participants can expect to receive. Life Estates pays for the cost of each appraisal so that participants aren’t a dime out of pocket.

Using the appraised value of the home, Life Estates then agrees to a pre-set annual appreciation rate which will be used to determine the value of the home on the death of the participant. In essence, Life Estates is guaranteeing the value of the participant’s home regardless of the condition of the real estate market at the time of death. Guaranteed appreciation? It’s hard to argue with that, especially in today’s comparatively soft real estate market.

This guaranteed purchase price is where the Life Estates program differs sharply from a reverse mortgage. With a reverse mortgage, compounding interest is constantly eroding the participant’s equity, a situation that worsens when real estate prices are low or declining. Home equity does not erode under the Life Estates program.

So how can Life Estates provide all of these good things to participants at seemingly no cost? The answer lies in life insurance. As part of the deal, Life Estates will take out a life insurance policy on the participant. The premiums to be paid by Life Estates, of course. This life insurance policy ensures that Life Estates has the necessary funds available to purchase the participant’s home from their estate on death. Life insurance also provides Life Estates with the profit it requires to carry on business. Notice that there are no mortgages or loans involved.

Next week, I’ll present some numbers to outline how the Life Estates program works in addition to addressing some of the more common concerns.

Jim Maroney is a chartered accountant with Andrews Brown Maroney in Maple Ridge.