Most homeowners dream of the day they make their final mortgage and own their home outright. Few think about what it might be like to have their home make payments back to them.
It is called a reverse mortgage, where for those of a certain age and who own their home outright can sell back a portion of their home to a lender, who then provides a portion of that equity back to the homeowner.
While the majority of homeowners of all ages continue to take the "re-fi route" when it comes to pulling additional capital out of their homes, a growing number, baby boomers in particular, are turning to reverse mortgages as a way to supplement their retirement income.
At first blush, a reverse mortgage, also known as a home equity conversion mortgage, sounds like a great idea: You continue to live in your home without having to make any mortgage payments, and at the same time receive a lump sum of cash to be used for whatever you like.
And for many it can be, in particular retirees and seniors who want to remain in their home, have various types of medical or other expenses, and yet are on a fixed income -- and therefore can't afford to take on more debt in the form of a new mortgage or line of credit.
Typically the loan does not have to be repaid until the house is sold or the homeowner passes.
While this might seem like a great deal, there are many rules, regulations and risks involved in obtaining a reverse mortgage.
For starters, to qualify for a reverse mortgage in Canada you must be over a certain age, usually at least 55 or 62, depending on the lender. You must also own the property outright, or be very close to owning it, and there can't be any other outstanding loans.
From there, there are many additional restrictions. The typical maximum a homeowner can get in a reverse mortgage is usually around 50 per cent of the property's market value, while the terms of the loan, including payments, interest rate and term, are dictated by the homeowner's age.
Then there are the regulations.
There are a ton of regulations involved in reverse mortgages, but they are still becoming more and more popular because frankly they can be beneficial. Like any mortgage or loan it is all situational. For some people a reverse mortgage is a great idea and maybe even their best option, but for others it is just a way to incur more debt.
Reverse mortgages can be beneficial for seniors with little to no income or those who have medical needs that cost a great deal. There is no income qualification for a reversed mortgage, so if you are around the age of 55-62 and you decide to stop working you can choose to live off of your home as opposed to struggling to make payments each months. I guess the idea here is that you have already spent a large portion of your life building equity in your home and this is a chance to live off of your assets instead of continuing to pay into them.
That being said, reverse mortgages are not for everyone. In Canada, reverse mortgages are available through private corporations only and are not insured by the government, which means you are leaving your money at the mercy of a corporation and could be taking a huge risk. You will also be paying more interest on your own equity. Interest rates on reverse mortgages are higher than those on traditional mortgages or credit lines. So, it may seem as though you are not paying monthly interest on your mortgage but you are actually accumulating more interest.
This compounded interest can cause the mortgage to balloon quickly and when the homeowner passes away or sells their home, that money will have to be repaid, leaving less cash for your estate or to pay your bills. This is the main idea that many people do not understand about reverse mortgages. Yes, in any mortgage you pay interest, but with a reversed mortgage you are paying more interest on the equity you spent your life building. So you do not have a monthly payment, but you are steadily losing equity in your home.
This is also why reversed mortgages are severely dependent on the situation. If a senior has had a successful life and so have their loved ones, they may not be as worried about leaving behind money or a paid off home, if you have a family, friends and/or spouse that you would like to leave money behind for then that is something you need to take into consideration, especially if most of your money is invested in your home.
Overall, the idea of reversed mortgages is great. It allows seniors to live off of the equity that they have spent their lives paying into. However, in actuality reversed mortgages can be very complicated and can leave seniors will a lot less money.
Seniors considering a reversed mortgages need to make sure they understand what they are getting themselves into. Monthly payments are no longer required, but your home equity will severely decrease. As previously stated, reverse mortgages are great for senior who have incurred an illness or have no form of income, but they are not appropriate for all seniors. If you can afford to continue making payments on your mortgage you may be better off continuing to do so and gradually increasing your equity as opposed to draining it.
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Before any fun can be had, it's best to use that remaining money to pay off any and all remaining debts that may be outstanding, starting with the debt with the highest interest. At the end of 2012, the average consumer debt load in Canada was $27,485 — a six per cent increase over the previous year and the fastest increase since 2009. Sure, such financial housekeeping seems boring and monotonous, but you'll thank yourself later. After all, financial freedom when other debt still hangs over you is nothing but a facade and the longer such debt is avoided and ignored while you live the high life, the sooner you'll be in an even deeper financial hole.
A number of financial experts and personal finance articles recommend paying off your mortgage before investing in your retirement, but once your mortgage is paid off, why not allow the money you are now saving to grow even further in an investment to put towards retirement? There are always a number of investment options to choose from, whether it be high risk high reward stocks, GICs, savings accounts, or mutual funds. What you choose is dependent on your risk tolerance and investment knowledge and your risk tolerance depends on how long the money will stay invested. More time means you can afford to take higher losses, but if you plan to cash out, you'll want to keep your losses to a minimum.
Once all outstanding debt is paid off, it's time to have some fun and live your dreams. An around the world ticket can be purchased through travel websites for less than you may think. The cost is determined by the number of countries you plan to visit, the class of your cabin and the total mileage the plane will be traveling. You'll also want to consider the flexibility that your trip allows and possibly using discount airlines, buses, or trains for shorter distances on your trip if money is still a main concern. An around the world cruise is also an option if money is no object and you want to live it up, with costs dependent mainly on your steerage class with trips ranging from $20,000 to over $100,000 depending on the cruise line and the type of room chosen.
Maybe you hate your job or maybe you just want to spend more time with the family; either way, no longer having the financial burden of a mortgage means you can start working the way you want. You can plan to retire sooner, thanks to all that extra money, maybe consider working part-time or even reinvest in yourself by changing jobs and doing what you always wanted to do or starting your own business and becoming a true entrepreneur.
Depending on how early you get your ducks in a row, paying off your mortgage may line right up with your kids, or possibly your grandchildren, going off to university. With the cost of tuition and living on your own being around $80,000, the kids will need as much help as they can get. If your kids have yet to reach university age, you can use your extra funds to make the maximum RESP contributions, as often paying a mortgage is a major barrier to parents making the real impactful contributions they want to their kids' education.
You may want to take that extra money and reinvest in your home. Those long planned renovations you always wanted to do can finally be moved to the forefront now. It's a great way to increase the value of your home if you sell it down the road. You could even put the renovation expenses on a line of credit and pay them off like you did your mortgage for a time.
Speaking of selling your home, many retirees realize that their home is actually more spacious than they need it to be, so it's common for many of them to downsize. The money you save from the sale and subsequent downsizing will only add to your financial options. The world is your oyster; now go out and claim it!
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