MORTGAGES: Reverse mortgage a no panacea

A reverse mortgage is often described as a way seniors -- those who are house rich but cash poor -- can continue to live in their homes and generate extra tax-free cash flow.

P.J. Wade, author of a 1999 book titled Have Your Home and Money Too, argues they are not only for the elderly destitute.

"It's a financial, lifestyle and wealth-management tool," she says, which lets homeowners convert their equity into cash without selling it or paying the debt until a pre-set time in the future.

In her 2008 e-book update, the title became Reverse Mortgages: Worst Enemy, Best Friend ... Your Choice! She says reverse mortgages are now being better marketed and the interest rates charged--about 4.5% -- are more in line with other financial options.

But there's nothing "reverse" about them, she cautions. "It does not easily reverse if you take the wrong product. You can use up your equity quickly. You need to look at every alternative before doing a reverse mortgage."

For those who have exhausted all alternatives, and for whom remaining in their home and community is paramount,

she says a reverse mortgage can be "your best friend."

The "mortgage" part of the name should serve as a reminder this is still a form of debt. As time marches on, this debt increases, contrary to traditional mortgages. This is also the opposite of what many seniors did early in their lives -- building up equity by paying down mortgages as soon as possible. Indeed, I'd argue a paid-for home continues to be an essential element of financial independence.

Like annuities, a reverse mortgage may deprive your heirs of capital. This may be no problem for seniors without kids, or those with well-off adult children who have no expectation of inheriting.

One advisor, who didn't want to be named, says a reverse mortgage can make sense if coupled with a conservative blue-chip stock portfolio.

"The interest becomes a deduction from income, which contributes to retirement lifestyle," the advisor says. "By minimizing capital withdrawals, the strategy can have a more neutral effect on wealth, particularly if the house continues to grow in value."

However, Warren Baldwin, regional vice-president with Toronto-based T.E. Wealth, is less enthusiastic. Once the lump sum goes into the account, the debt tends to become "outta sight, outta mind," he says.

Since interest rates and terms and conditions can be expensive, seniors may be better off with a simple line of credit from the bank, Baldwin says.

Interest payments would be lower, there are no repayment penalties and the senior can draw against it in small increments. A line of credit reinforces the perception that debt is being increased. By contrast, a lump sum from a reverse mortgage tends to lead to spending or gifting away the funds while forgetting the original source was debt.

Graham Cook, president of Nanaimo, B.C.-based Composite Finance Inc., suggests a simple alternative is the Manulife One account, which provides a line of credit of up to 80% of a home's value. Interest of about 1% is paid on any positive balances, while interest of about 3% is charged on net debt owing.

Before resorting to reverse mortgages or lines of credit, seniors should consider whether they can really afford their lifestyle--including home ownership. Alternatives are to sell and downsize to a condo or rent an apartment.

Until recently, there were only two major providers of reverse mortgages in the Canadian market. The incumbent, Vancouver-based Canadian Home Income Plan Corp. (CHIP) was founded in 1986 and in 2009 became a chartered bank, the HomEquity Bank, a publicly traded company [HEQ] on the Toronto Stock Exchange.

The new entrant, Oakvillebased Seniors Money Ltd., ran into problems when its funder, the Commonwealth Bank of Australia, disappeared after the 2008 credit crunch. According to president Nick DiRenzo, the firm still services existing clients but is not pursuing new business while it seeks a new business model.

By contrast, there are almost 40 suppliers in the United States, says Greg Bandler, senior vice-president of HomEquity Bank. Asked about the horror stories occasionally reported in the U.S. media, Bandler said the U.S. reverse mortgage business is regionalized while HomEquity Bank has relationships with all major Canadian banks, mortgage brokers and wealth managers.

The mortgages are conservative, lending only up to 40% of the value of a home.

"We can guarantee that the value of the loan never exceeds the fair market value of the home," Bandler says. Most clients still have at least 50% equity left in the home when sold.

A reverse mortgage should not be an act of desperation. Wade says the best time to research them is before you need one.

(prepared by Johnathan Chevreau/Financial Post/National Post)