The concept behind a reverse mortgage is that the homeowner gets to spend some of the equity in their home
Maroney on Money for November 2, 1997
You work a better part of your life to pay off your mortgage and then someone comes along offering to put you back into debt when you retire. Thanks, but no thanks. Everyone knows that you should be debt free when you retire. But what if the debt being offered is a “reverse mortgage”?
Those who have had a "non-reverse" mortgage would no doubt like to believe that a "reverse" mortgage entails the bank repaying all the interest paid to them over the years. Unfortunately, it just isn't so.
While reverse mortgages are not particularly well known or understood, they have been around since 1987. The concept behind a reverse mortgage is that the homeowner gets to spend some of the equity in their home without selling or moving. The equity is received tax free and is available as either a lump-sum, a regular monthly income or a combination of both.
The receipt of tax free income is made possible by the homeowner placing a mortgage on his or her home at a stated interest rate. The mortgage proceeds are typically used to purchase a life annuity which provides non-taxable income to the purchaser. Generally the mortgage interest rate exceeds the annuity interest rate by 1.5% thereby ensuring the amounts received are not subject to tax.
The mortgage becomes due and payable on the death of the homeowner (or last survivor) or upon sale of the home. In the interim, no payments are due on the mortgage. Interest simply accrues on an ever increasing balance.
The terms of the mortgage are usually set so that 25% of the homeowner's equity remains, assuming death occurs at life expectancy. In essence, the financial institution is betting the homeowner won't survive beyond what the life expectancy tables show.
If you happen to live considerably longer than your life expectancy, the mortgage and accumulated interest may actually exceed the value of your home. In such a case, the loss belongs to the financial institution.
The amount that can be borrowed will depend upon the age of the homeowner(s). Age is used to determine how much can be borrowed and also how much is paid under the life annuity. The younger the applicant the less that can be borrowed and therefore, the less that can be paid.
Other factors that determine how much can be borrowed include current interest rates, location and value of the home and the value of an existing mortgage, if any.
So what do most applicants do with the money they borrow by way of a reverse mortgage? Often the funds received are used to supplement the regular monthly income of seniors who are asset rich and cash poor. Other common uses include travelling, home renovations, major purchases (e.g., new car or RV) and, believe it or not, to pass money onto the next generation.
Next week I’ll review a typical scenario and answer some of the more frequently asked questions.
Jim Maroney is a chartered accountant with Andrews, Brown, Maroney in Maple Ridge.
|
