In reverse

On a day when man hurtles off to the moon for the first time in half a century while wars on earth rage, daily life goes on. People get married, get families, get old.

This blog has oft told you what matters. Forget macroeconomics and geopolitics. Focus on what you can do in your own time and for those around you. Make good decisions for sound reasons. Others depend on you.

Now, in this context, John has a simple question about his folks.

Please give me your opinion if getting a reverse mortgage on a home in order to finance home care for elderly parents is a good idea.

Well, it’s an option. Many have been lured in by this product – to the point where more than $8.5 billion in such loans have been taken by Canadians over then age of 55. In fact, this is the fastest-growing segment of residential real estate debt.

No wonder. We have an aging population and surveys show 90% of people in their forties and beyond never, ever, ever, ever want to go into a retirement home. The majority of us wish to live in familiar surroundings, die peacefully in our sleep and be planted in the garden.

But that takes a heap of money. Pensions are on the decrease. Savings are harder to accumulate. Most people, sadly, end up with inadequate liquid investments and the bulk of their net worth in a house. It’s the Canadian way, which is why we have this crazy-high home ownership rate and stagger through life paying off massive mortgage debt. In retirement we have wealth, but little money.

Enter the reverse mortgage.

Simple idea. Give oldies a hunk of dough represented by equity in their real estate. They get to stay in the house but don’t make loan payments. In return charge them interest on the outstanding amount, added to the principal, and when they sell or croak you get the loan amount and accumulated interest returned. It’s a business model which HomeEquity Bank (it funds the CHIP reverse mortgage) has judged a winner.

But is it good for the clients?

Sometimes, for sure. If the wrinklies don’t have enough income to carry their home or hire caregivers or to make essential repairs – and really don’t fuss about their equity being sucked off each month, or the value of their estate squished – a reverse mortgage is a viable option.

But this product comes with overhead. For starters, there’s a punitive rate of interest charged on the amount handed over to then homeowners. Here’s the latest CHIP rate sheet. You can see the cost is about double that of a conventional mortgage.

This means debt accumulates fast when no monthly payments are being made to reduce the outstanding principal. For example, a couple taking a $200,000 reverse mortgage at a rate of 9% would owe almost $472,000 in just ten years.

Yup. Doubled. That’s what compounding interest does.

Of course, as that debt grows from two hundred grand to four hundred, the remaining equity in the real estate shrinks. While the financial company gives a guarantee it will never lay claim to more money than is actually available in a property (if real estate values plunge during the life of the reverse mortgage) it also means 100% of the equity can be consumed upon death. Nada for the heirs.

As we’ve always pointed out, this is a great strategy if you hate your kids.

There’s more. Setup charges are involved for the reverse mortgage. And the payback period after a borrower passes is limited to a few months. So the kids/heirs have to come up with the money to repay the lending bank, or quickly sell the home in order to do so. Also, by tapping into home equity to pay for day-to-day costs, the wrinklies might find themselves short of resources later in life if medical expenses grow – or that dreaded nursing home care is required.

So, John, it’s an option. Not then best one. But it’s there and it works for many.

Better idea? Support your parents as they supported you. Let them tap into their real estate wealth with a home equity LOC which you can co-sign. Far cheaper. Sell their home, invest the cash, and set them up in a nice, safe rented condo. Or maybe find a real estate investor who will buy the place and let them live on, paying simple rent which can be generated from the proceeds, while retaining the principal amount for the future, or the estate.

The best idea: plan ahead. Some day you, too, will be old. Make it debt-free. Learn.

About the picture: “Long time reader, first time emailer!” writes Paul.  “Wanted to thank you for the blog, I have been a reader since 2009. I always appreciate the level headed analysis of current events and consistent investment advice. You’ve helped steer me into a pretty decent situation, was able to achieve the goal of 90 at the age of 39 while owning a modest home in KW. This is Frankie, she is a Pot-Cake from the Bahamas.  Outside she is a crazy zooming dog that wants to hunt, herd and play hard.  Inside she is a couch hog that is content to snore the day away, get treats and pets of which there are plenty!  She has been up here for almost 4 years and doesn’t seem to hold it against us that we brought her into these cold Canadian winters from the streets of balmy Nassau.”

To be in touch or send a picture of your beast, email to ‘garth@garth.ca’.