What are the options for retired people that become house rich and cash poor? Our last column touched on one simple strategy that we really like – deferring property taxes. Another strategy that people have asked us about are reverse mortgages. What are reverse mortgages and when do they make sense?
Reverse mortgages are residential first mortgages secured by a specific property, and offer individuals over the age of 60 a means of converting a portion of the equity in their home into cash. Let’s compare a regular mortgage with a reverse mortgage.
With a regular mortgage interest and principal payments are made on the original amount borrowed. With a reverse mortgage individuals may request an amount based on the equity in their homes. However, no interest or principal payments need to be made until you move out of or sell the home.
Reverse mortgages are offered through the Canadian Home Income Plan Corporation (CHIP). This Corporation refers to them as CHIP Home Income Plans. CHIP began operations in British Columbia in 1986, before moving into Ontario in 1996 and the rest of Canada in 1998 and 1999.
From CHIPs website www.chip.ca you can obtain the following information:
- You can receive between $20,000 to $500,000 from your home equity. The specific amount is 10% to 40% of the current appraised value of your home, based on your age and that of your spouse, and the location and type of home you have.
- The current interest terms are: six months 7.5%, one year 8.25%, three years 8.60%.
- Annual discounts are available after three years and balance discounts are available if the outstanding balance on your CHIP Home Income Plan exceeds $100,000 or more.
- Set up costs that the home owner pays are approximately $675 which is an estimate of the independent home appraisal costs and independent legal advice.
- In addition, closing costs of $1,285 are added to your CHIP Home Income Plan.
- You have the option to repay in full at any time. When you repay, an interest differential may apply (limited to three month’s interest). If you repay within the first three years, a prepayment amount will apply. These may be waived or reduced in the event of death or a move to a long-term care facility or retirement residence.
Let’s use an example of a 65 year-old living in a $500,000 home that requests proceeds of $80,000 under the CHIP Home Income Plan. This individual would have initial costs of approximately $675, representing estimated appraisal costs of $275 and independent legal fees of $400. In addition, closing costs charged by CHIP of $1,285 would be added to the CHIP Home Income Plan resulting in an initial balance of $81,285.
Interest would begin accruing on the initial balance of $81,285 on the one year CHIP plan at a current rate of 8.25 per cent. The net proceeds are approximately $79,325 ($80,000 received from CHIP less appraisal and legal fees of $675). Remember, individuals that participate in these plans are not required to make payments. The compounding component magnifies when no interest or principal payments are made. The accumulated cost under the CHIP plan after years one, two and three are $88,129, $96,239, and $105,096, respectively.
With the CHIP plan individuals are initially required to withdraw a minimum of $20,000. The set up costs as a percentage based on this amount is high. This may encourage individuals to take a greater lump sum when they may need a much smaller monthly amount. Is the CHIP plan the best option for an individual that only needs an extra $500 a month to make ends meet?
These plans are costly to set up. The interest rates charged are higher than posted rates on standard mortgages. As an example, the current three-year CHIP rate is 8.6%, compare that to 6.1% representing the average posted rate of the chartered banks for the same term. If the fair value of your home is not appreciating then the interest accrued can quickly wash away equity in your home.
The CHIP plan is voluntary and provides a unique opportunity for individuals to stay in their homes that they live in while enjoying retirement. It may be difficult for some individuals to see this component of their equity diminish. Possibly the saying, “you can’t take it with you” applies to those who are not interested in maximizing the value of their estate. A CHIP plan may be a way to have your cake today and eat it too!
Here are some basic strategies to assist individuals in staying in their homes:
- While you are still working and eligible to qualify for a line of credit we recommend that you do so prior to retiring. We also recommend that you apply for the maximum limit that you can qualify for. Having this in place may provide you the flexibility of drawing only what you need at retirement (i.e. $500 per month). The interest rate charged will likely be more competitive than a reverse mortgage.
- If you’re over 60 years old and cash flow is a concern, you may want to consider the Property Tax Deferment program.
- If you are running low on retirement funds you may want to consider paying interest only payments on certain debts such as your line of credit. Paying interest only payments on debt that has a reasonable interest rate may provide the necessary capital to prolong the stay in your home.
- Peace of mind at retirement can certainly be enhanced in the absence of financial concerns. Sometimes downsizing into a smaller home may provide the necessary capital to fund retirement expenses.
- Utilizing a reverse mortgage is always an option. The Chip Plan does provide individuals the ability to stay in their homes longer, but at a cost.
Individuals that are interested in a reverse mortgage must seek independent legal advice. On a cautionary note, people who are interested in a reverse mortgage should also consult with their investment advisor or accountant to determine if a reverse mortgage is the best strategy and if it makes sense for them.