Tuesday, November 15, 2005

Reverse Mortgages

Reverse mortgages are promoted as a means for seniors to use the equity in their homes to finance their needs and lifestyles.

Like a conventional mortgage, a reverse mortgage is a loan secured by a mortgage against the borrower’s home. Unlike a conventional mortgage, the borrower is generally not required to repay the loan until the borrower sells the home, or until the borrower’s death. The principal and interest on the loan becomes due when the home is sold, or within a specified period after the borrower’s death.

Often, reverse mortgages will provide that the borrower’s liability to the lender for the principal and interest is limited to the value of the home. This means that the borrower or the borrower’s estate will not have to make up any shortfall if the amount owing on the loan exceeds the value of the home when the home is sold, or when the borrower dies.

There are both advantages and disadvantages of reverse mortgages. A reverse mortgage does offer people who are house rich and cash poor a way to stay in their homes, while maintaining their lifestyles.

The main disadvantage of a reverse mortgage is that, because interest rates on a reverse mortgage tend to be higher than on a conventional first mortgage, interest is compounded, and the borrower is not required to make monthly payments of interest and principal, the amount that the borrower or the borrower’s estate will have to eventually repay will increase substantially over a long period of time. For example, if you borrow $50,000 at 7 % per year interest, and do not make any payments, the amount owing on the loan will double to $100,000 within ten years, and double again to $200,000 within another ten years. (The interest rates on reverse mortgages usually fluctuate, moving up and down over time, which makes it difficult to calculate the amount the borrower will ultimately have to pay.)

The increase in the amount owing on a reverse mortgage can create a hardship for the borrower if the borrower later decides to sell the home to move into a smaller place. If under the terms of the reverse mortgage, the loan becomes due when the house is sold, and if the amount owing has grown substantially there may not be enough equity in the home left to buy another, even if less expensive, home.

Before deciding whether to enter into a reverse mortgage agreement, one should carefully consider the potential costs of the loan in the future if the home is sold, get legal advice on the terms and the reverse mortgage, and get financial advice on alternatives. For example, in British Columbia, seniors may be able to defer property taxes on their homes under the Land Tax Deferment Act, RSBC 1996, c. 249.

The Canadian Centre for Elder Law Studies has published a “Consultation Paper on Reverse Mortgages” which provides more information on reverse mortgages and a discussion on ideas for law reform on this topic. The Consultation Paper can be found here.

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