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July 18, 2018 | The Big Suck

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Karen’s discovering GreaterFool Rule 4. Just in time.

Widowed, 63, retiring in 14 months, single, two adult children (far away) and a pension, “that won’t attract flies, it’s so bad.” But she won the birth lottery and lives in the same home she and Dan bought a few decades ago. These days it’s worth about $800,000. No mortgage.

The trouble is simple: cash flow. K has less than $150,000 in her TFSA and RRSP combined – plus that pension which will pay under a grand a month. “Like you say on the blog,” she told me yesterday, “I’m probably pooched.”

Which brings us to Rule 4: When thou art a wrinkly, way better to have cash flow than house.

Karen actually called me because some dude from Equitable Bank contacted her to pitch that company’s new reverse mortgage. It seemed like a dream solution by the end of the call. “He said I can borrow about $400,000, and never pay it back!,” she said. “So I could invest it and make money to live on, or just spend it, or maybe buy an investment condo that would pay me rent every month. And I never have to make any payments on the loan – just give them the money out of the house when I croak. So I’m tempted. What choice do I have. I dare you to talk me out of it.”

Hey, K, I don’t judge or bully. Let’s just deep-dive this for a minute.

Reverse mortgages aren’t new. But they’re popular like never before. Easy to see why. First, at least four in ten end their careers with diddly saved – a total indictment of their time on this earth. But it’s real. Second, most people retire with real estate, mostly paid for. Third, house values went nuts for a decade, creating windfall wealth to tap into. Fourth, corporate pensions are dying out fast and nobody can live on government pogey. Fifth, like trout, humans just want to go home to die. The Equitable Bank guy knows this, as do the clever marketers at HomeEquity Bank – the two Canadian providers of reverse mortgages.

The idea ‘s simple: borrow against the equity in your house to gain a tax-free lump sum and make no repayments until you sell the place or die. For people with real estate and no liquid wealth, it seems like a godsend. But the devil is in the details. As a result, so many old farts among are falling for a scheme that surgically separates them from their wealth.

Things to consider:

This is a mortgage, not a simple loan. Interest accrues constantly because no payments are being made on an amortized debt. Soon you’re being charged interest upon interest. It doesn’t take too many years for the original amount of the loan to turn into a debt double or triple the original amount.

Supposedly people qualify to borrow 55% of their equity after achieving the age of 55. But that’s not true. The bankers really want the oldest possible borrowers, preferably male, who are closest to departing this mortal coil and enjoying their 40 celestial virgins (that’s coming, right?). That way their funds (and profits) are closer to being collected. Younger wrinklies get less.

The rate on a reverse mortgage is outrageous. Current with HomeEquity’s CHIP program (the biggest), for example, the five-year rate is 6.78%. That means $300,000 borrowed now becomes $450,000 in five years and about $625,000 in a decade.

So, reverse mortgages are great if you hate your children. Because when you kick and the house is sold, there may be zippo left after the debt’s repaid.

This might be the worst time in years to contemplate a reverse mortgage – just when interest in them is exploding. Why? Because the bubble’s over. The combination of rising interest rates and restricted credit means real estate values will moderate or fall – at the same time borrowers are seeing their equity sucked off. It may not take long to entirely drain the pot.

And remember Rule 4 – you need income, not real estate, especially when the serious wrinkly years commence. People in their 80s often have to seek more appropriate accommodation with fewer stairs and more assistance. If they’ve just spent a decade or more consuming their home equity, they may have precious little left to finance the rest of the journey. That would suck.

So what are the alternatives if you have a house and no money?

There are a few.

Before you retire and give up your steady income, arrange a HELOC. A home equity line of credit may be a better choice since the interest rate is lower, interest-only payments can be made, it can be retired or reduced at any time, there is no interest-on-interest and the money you pay to maintain it can be 100% tax-deductible if you invest the funds to give yourself a retirement income stream.

Of course, you can always rent out part of your home to some desperate Millennial. Or AirBnB the place. Or list and downsize. Or, better yet, sell, cash out and invest in a prudent portfolio creating a steady, tax-efficient income stream to pay your rent. That way real estate equity is liberated instead of being sucked off by the giant CHIP proboscis. You can enjoy monthly cash flow, fund your accommodation and still retain a nestegg to pass on to your undeserving heirs.

Or, even better, spend it all. You’re not leaving here alive.

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July 18th, 2018

Posted In: The Greater Fool

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