PETER DOLEZAL: Updating reverse mortgages

A reverse mortgage, available to Canadians 55 and older, is a vehicle for extracting up to 50 per cent of the equity in an owned residence

A reverse mortgage, available to Canadians 55 and older, is a vehicle for extracting up to 50 per cent of the equity in an owned residence. Because the Canadian Home Income Plan (CHIP) requires no payment of principal or interest until the home is sold by either the owner or the estate, many seniors find this a tempting avenue for accessing some of their equity. They should avoid the temptation. Instead, a reverse mortgage should be considered an absolute last resort for the generation of needed capital.

What is the catch? Then first introduced in the late 1980s, the CHIP program met a lukewarm reception. By 2003, only 5,500 Canadians held a reverse mortgage. However, ten years later about 2,500 Canadians are signing up annually — enriching the primary provider, The Home Equity Bank, with an additional $250 million of risk-free business.

The Bank boasts that some three years ago it drastically reduced the interest rate it charged on reverse mortgages. Despite this reduction, as of early July this year, the five-year fixed-rate on offer stood at 5.45 per cent. Considering that a borrower can still secure a normal 5-year fixed-rate mortgage at a little over three per cent, the reduced CHIP rate is no bargain. And, since a five-year term is the longest offered by the CHIP program, the homeowner is fully vulnerable to the effect of rising interest rates when the five-year term expires.

Apparently, after entering the CHIP program, the average holder of a reverse mortgage remains in the encumbered home for about 12 years. Even in the unlikely event that today’s CHIP borrowing cost of 5.45 per cent remains unchanged for 12 years, a homeowner who today extracts $200,000 from his home equity using the CHIP program, will at the end of 12 years, have an accumulated interest and principal obligation totaling $384,000.

In reality, with rising interest rates on the horizon, this accumulated indebtedness is likely to be much higher. The younger the homeowner when signing up for a reverse mortgage, the greater the ballooning obligation is likely to be when the home is eventually sold.

Not only is the homeowner settling for a high borrowing cost, but he also finds himself subject to initial set-up costs of at least $2,000. In our $200,000 example, this would result in net proceeds of only around $198,000.

Most of us are familiar with the highly beneficial effects of interest compounding when applied to our investments. The reverse mortgage applies this same compounding principle — however in this case, the effect works against the homeowner, eroding at an ever increasing pace, the accumulated equity in his home.

Should a prudent homeowner always steer clear of the CHIP program?

To be fair, there is a circumstance which might make sense.

A healthy retiree who either has no heirs or no plan to leave a significant estate, may find the CHIP program of benefit. In this case, the eroding value of his equity may be of less concern — although adequate home equity may still be required to fund eventual care in a long-term facility.

Before considering the CHIP program, first exhaust all other options for enhancing cash flow. This could include deferring property taxes, or downsizing to a less expensive home.

Before making a commitment to a reverse mortgage, consult with family to see if they can suggest a better solution.

If you still feel you need to use the CHIP program, first consult with independent financial, and legal advisors, to ensure you have a full understanding of the full consequences of proceeding.

The negative factors associated with the CHIP program seem to greatly outweigh the possible benefits. I would never allow the magic of compounding, at high interest rates, to work against me, for the risk-free benefit of a reverse mortgage provider. Do not let yourself be charmed by the slick advertising of the CHIP providers — protect your hard-earned equity.

 

A retired corporate executive, enjoying post-retirement as an independent financial consultant, Peter Dolezal is the author of three books, including his most recent – The SMART CANADIAN WEALTH-BUILDER.

 

 

Just Posted

Sofia Watts, Charlotte Magill and Harriet Knight were among the KELSET Elementary School students releasing salmon fry into Reay Creek May 7. (Ian Bruce/Submitted)
Saanich Peninsula elementary students help restock, clean up local creeks

Salmon fry releases took place at Reay Creek and Tetayut Creek

The City of Victoria hopes to improve its cultural spaces this year and it wants non-profits to help. (Black Press Media File Photo)
Grants up to $125,000 open to Victoria non-profit arts and cultural organizations

Victoria Cultural Infrastructure Grant applications close at the end of May

(Black Press Media file photo)
Saanich health and safety manager named one of Canada’s top 40 women in safety

Canadian Occupational Safety magazine celebrates women leading safety sector in 2021

North Saanich has started the design of a crosswalk at the intersection of Mills and Littlewood roads near Garden Child Care Centre, whose owner Tracey McCullough has been calling for such a sidewalk. As such, she has been echoing a previous appeal by the building’s owner, Heather and Cory Hastings, standing respectively with seven-year-old Jack Hastings and five-year-old Felix Hastings. (Black Press Media File)
North Saanich moves ahead with crosswalk near child care centre

Crosswalk proposed for Littlewood and Mills roads parts of approved active transportation plan

Colwood city council did a last minute adjustment to this year’s budget, dropping the planned property increase to five per cent. Last year they didn’t increase taxes at all. (Black Press Media file photo)
Colwood agrees to 5% tax increase for 2021, deferring some expenses to next year

Last-minute changes will save the typical Colwood homeowner $56

Daily confirmed COVID-19 cases reported to B.C. public health, seven-day rolling average in white, to May 12, 2021. (B.C. Centre for Disease Control)
B.C. preparing ‘Restart 2.0’ from COVID-19 as June approaches

Daily infections fall below 500 Friday, down to 387 in hospital

A vial of AstraZeneca vaccine is seen at a mass COVID-19 vaccination clinic in Calgary, Alta., Thursday, April 22, 2021. Dr. Ben Chan remembers hearing the preliminary reports back in March of blood clots appearing in a handful of European recipients of the Oxford-AstraZeneca COVID-19 vaccine. THE CANADIAN PRESS/Jeff McIntosh
Science on COVID, VITT constantly changing: A look at how doctors keep up

While VITT can represent challenges as a novel disorder, blood clots themselves are not new

Poached trees that were taken recently on Vancouver Island in the Mount Prevost area near Cowichan, B.C. are shown on Sunday, May 10, 2021. Big trees, small trees, dead trees, softwoods and hardwoods have all become valuable targets of tree poachers in British Columbia as timber prices hit record levels. THE CANADIAN PRESS/Jen Osborne.
Tree poaching from public forests increasing in B.C. as lumber hits record prices

Prices for B.C. softwood lumber reached $1,600 for 1,000 board feet compared with about $300 a year ago

The warm weather means time for a camping trip, or at least an excursion into nature. How much do you know about camps and camping-related facts? (John Arendt - Summerland Review)
QUIZ: Are you ready to go camping?

How many camp and camping-related questions can you answer?

On Friday, May 14 at Meadow Gardens Golf Club in Pitt Meadows, Michael Caan joined a very elite club of golfers who have shot under 60 (Instagram)
Crowds at English Bay were blasted with a large beam of light from an RCMP Air-1 helicopter on Friday, May 14. THE CANADIAN PRESS/Marc Grandmaison
Police enlist RCMP helicopter to disperse thousands crowded on Vancouver beach

On Friday night, police were witness to ‘several thousand people staying well into the evening’

Sinikka Gay Elliott was reported missing on Salt Spring Island on Wednesday, May 12. (Courtesty Salt Spring RCMP)
Body of UBC professor found on Salt Spring Island, no foul play suspected

Sinikka Elliott taught sociology at the university

The first Black judge named to the BC Supreme Court, Selwyn Romilly, was handcuffed at 9:15 a.m. May 14 while walking along the seawall. (YouTube/Screen grab)
Police apologize after wrongly arresting B.C.’s first Black Supreme Court Justice

At 81 years old, the retired judge was handcuffed in public while out for a walk Friday morning

Queen Elizabeth II and Clive Holland, deputy commonwealth president of the Royal Life Saving Society, top left, virtually present Dr. Steve Beerman, top right, with the King Edward VII Cup for his drowning-prevention work. Tanner Gorille and Sarah Downs were honoured with Russell Medals for their life-saving resuscitation. (Buckingham Palace photo)
Queen presents Vancouver Island doctor with award for global drowning prevention

Dr. Steve Beerman receives Royal Life Saving Society’s King Edward VII Cup at virtual ceremony

Most Read