Mortgage Blog

Reverse mortgages are cheaper than ever. Should you use one to tap into your home's equity?

February 28, 2020 | Posted by: Aaron Baxandall

By David Aston Tues., Feb. 25, 2020

If you're a cash-strapped retiree with lots of equity in your home, you're probably wondering how you might turn soaring housing prices to your advantage without having to sell your home and move.

The reverse mortgage lets you tap into your home equity in just that situation. It allows you to take out a loan against your home equity, up to a certain percentage of your home's value. You don't need to make payments on the reverse mortgage until the loan is due — typically when you move, sell your home or the last borrower dies.

While the niche product has been available in Canada since 1986, the current combination of low interest rates, skyrocketing home prices and increased competition helps to make it a particularly appealing option these days.

Those conditions are helping to drive 'breakout growth' for reverse mortgages in the order of 20 per cent a year, says Robert McLister, founder of RateSpy.com, a mortgage news and rate comparison site.

The main factor holding reverse mortgages back from being even more popular is that they still tend to be more costly than conventional mortgages and so are seen as relatively expensive.

But that gap appears to be narrowing. Equitable Bank, the smaller of the two reverse mortgage providers, has been aggressive with interest rate cuts.

With the latest rate reductions, Equitable achieved a major milestone by slightly undercutting interest rates for Home Equity Lines of Credit (HELOCs) for the first time with a specific type of reverse mortgage — one that has a one-year term with the money borrowed all at once in a lump sum. Equitable's new rate for that particular product is 4.44 per cent, which is a shade lower than the average HELOC rate of 4.45 per cent, reported RateSpy.com.

While comparing more favourably with HELOCs is a welcome change, it should be clear that most types of reverse mortgages are still quite a bit more expensive than most types of conventional mortgages.

For example, if you want a five-year fixed rate reverse mortgage but don't want to take the entire amount at once in a lump sum, then you'll still pay an interest rate well above five per cent with both reverse mortgage providers.

In comparison, you can get a conventional five-year fixed rate mortgage with an interest rate just under three per cent these days. While the overall rate gap with conventional mortgages has narrowed, it's still significant.

Despite increased competition, the reverse mortgage market is still dominated by a single nationwide provider. HomeEquity Bank pioneered the product in Canada in 1986 and was the sole provider for many years. It often operates under the CHIP name.

But Equitable Bank started offering reverse mortgages in 2018 and recently became more aggressive in offering better rates and terms to win business. 'Equitable Bank changed the market over the last year or so,' says McLister.

Equitable has been particularly aggressive on its lump sum rates, but has also achieved a narrower edge over HomeEquity's posted rates for other types of reverse mortgages. 'There has been a perception that this product is unwieldly expensive and we're doing a lot to address that,' said Paul von Martels, Equitable's vice-president of prime and reverse mortgage lending.

HomeEquity has yet to match the latest rate cut by Equitable, but it has its own areas of advantage. For one thing, it is generally willing to lend larger amounts. HomeEquity lends to a maximum of 55 per cent of home value, whereas the maximum for Equitable is a much more conservative 40 per cent. HomeEquity is also a nationwide provider active in all 10 provinces, whereas Equitable only operates in major urban centres in four provinces (Ontario, B.C., Alberta and Quebec). With decades of operation and a nationwide presence, HomeEquity Bank has accumulated outstanding reverse mortgage balances of around $4 billion, whereas Equitable Bank has only a fraction of that, at just over $20 million.

The great advantage of a reverse mortgage for cash-strapped retirees is that you don't have to make any payments, while you're also assured of being able to stay in your home for as long as you want or until you die. Meanwhile, the principal and interest quietly accumulate in the background, typically to be repaid out of eventual home sale proceeds.

Still, key features are not always understood by the skeptical public. 'The biggest misconception out there — which has been a thing for 20 years — is that somehow, when the mortgage comes due, we're going to end up with the house, which is completely untrue and has never been true,' says Steven Ranson, HomeEquity Bank president.

You can take a reverse mortgage as a lump sum all at once, or in periodic dollops of cash, or largely in a stream of regular monthly amounts. You can borrow for fixed terms of one to five years or with a variable rate.

While some seniors use it to supplement their retirement lifestyle or help pay for home care costs, others use it to pay off debts they've carried into retirement, including conventional mortgages where they struggle to cover required payments. You can get a reverse mortgage from mortgage brokers or directly from HomeEquity Bank.

Take a careful look at penalties and fees. There are prepayment penalties which may apply if you repay the mortgage within a period of 10 or 11 years, but typically the penalties are partly or fully waived under a number of circumstances such as the death of the borrower or a move into a long-term care facility. Allow a hefty $2,200 to $3,000 for closing costs.

HELOCs offer another borrowing option. Usually, a HELOC lets you borrow more, typically 50-65 per cent of the home's value. Despite the current parity with Equitable Bank's lump sum one-year fixed rate, HELOCs generally charge lower interest rates than most reverse mortgages.

However, many seniors can't qualify for HELOCs, points out McLister. Also, HELOC providers may cap your borrowing unexpectedly or possibly even require repayment of the entire loan, which may force you to sell your home at an inopportune time.

While seniors often worry that a reverse mortgage might gobble up all their home equity, that usually doesn't happen. Historically, more than 90 per cent of HomeEquity Bank's borrowers still have equity worth at least half the home's value when the loan is eventually paid off, says Ranson. 'Most of the time, there's a lot of equity left,' he says.

What many people don't realize is that if there is a certain amount of moderate growth in the overall value of the home, the dollar value of the equity will continue to grow even though the loan balance is also growing.

Of course, the home equity will indeed dwindle if home prices stagnate (or worse, if they shrink) but there will usually still be quite a bit of equity left after 10 or 15 years. If you then decide to sell your home so you can move to a retirement home or long-term care facility, then that remaining equity should come in handy in covering the often sizable costs of those forms of accommodation.

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