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Imagine this scenario: Samantha is retired at 69, but a few years back she took out a reverse mortgage. Now, she’d like to be done with it, especially since the loan comes with a hefty interest rate of 6.75%.
She currently has about $375,000 in home equity while her reverse mortgage loan is close to $250,000. She also has about $300,000 in savings, but she’s wondering if she should use a chunk of those savings to pay off her reverse mortgage and live on her Canada Pension Plan (CPP) — just over $1900 — instead.
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Or, does it make more sense to stick with the status quo?
How does a reverse mortgage work?
A reverse mortgage allows homeowners who are at least 55 to borrow money based on the equity on their home. (Your equity is based on how much you’d get if you sold your home, minus how much you have left on your mortgage.)
Unlike a traditional mortgage, you don’t make monthly loan payments. Instead, the lender pays you, using your house as collateral.
"A reverse mortgage is a type of loan for homeowners, usually aged 55 or older. It allows you to borrow money from your home equity without selling your home. You may do so by converting a portion of your home equity into tax-free money. Financial institutions sometimes call this ‘equity release’" according to the federal government’s website (1).
Because it isn’t considered income, the money is tax-free and won’t generally impact your CPP. But, you still have to pay property taxes and insurance.
Interest accrues on the loan balance, meaning the amount you owe goes up over time. If you have a high interest rate, that can add up — and fast.
It increases your debt while decreasing your equity, and the interest added to your balance each month can use up much — or even all — of your equity, according to Bloom Financial (2).
The total (including interest) must be repaid either when you move out and sell your home or after you pass away, in which case it must be repaid by your estate.
If you sell your home, you can use part of the proceeds of the sale to pay off the loan. This could make sense if you want to downsize or move in with family, or if you need to move into an assisted living facility.
However, if you continue living in your home until you pass away, your heirs will inherit the house — and the reverse mortgage.
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Options for paying off a reverse mortgage early
Maybe Samantha wants the peace of mind of owning her home, or maybe she wants to leave the house to her children without burdening them with debt. Whatever the reason, she does have a few options.
One of those options is to do nothing. She could choose to remain in her home, with enough money coming in from CPP and her retirement savings to enjoy a comfortable retirement.
When she passes away, her children could sell it and use the proceeds to pay off the reverse mortgage. It’s a trade-off: Samantha lives more comfortably and leaves less to her children, or she lives a more spartan lifestyle to leave more to her children.
If Samantha does decide to pay the loan off early, she could consider paying it all off in one lump sum, making a partial payment or making loan payments to reduce her interest over time (you usually have the option to pay off the principal and interest in full at any time).
However, depending on the conditions established with the lender, early repayment may incur monetary penalties, so it’s always best to consult with lender to clarify this. If you’re still on the fence about early repayment, consult with a trusted advisor who has a more holistic view of your financial situation. This could help you make an educated decision based on calculations instead of emotion.
Additionally, Samantha could keep the reverse mortgage and invest that money conservatively as part of her long-term retirement plan.
In this case, she could open a discount brokerage account, like CIBC Investors’ Edge, so she can enjoy low commissions on trades and no or minimal account maintenance charges, depending on the size of her portfolio.
With CIBC Investors’ Edge there are no account fees for RRSPs with a balance of $25,000 or more and TFSAs with a balance of $10,000 or more. For non-registered accounts, the platform waives maintenance fees if the account balance exceeds $10,000.
Even if Samantha can live off her CPP and savings, she’ll still be responsible for paying property tax, insurance and maintenance on her home. Plus, she may not want to drain her savings in case she needs that money for an emergency or future medical care.
With the extra cash she has, she could build a comfortable emergency fund using a high interest savings account.
For example, open a personal account with EQ Bank and in just a few minutes you get access to the best features of a chequing account combined with a high-interest savings rate.
When you fund your account and set up a direct deposit, you can earn up to 3.50% on every dollar deposited into the account. The account has $0 monthly fees and no minimum balances. Plus, you can withdraw from any ATM in Canada — for free.
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Article sources
We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.
Government of Canada: Reverse mortgages (1); Bloom Financial: Pros and Cons of Reverse Mortgages in Canada (2)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.