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January 25, 2019 | Reverse Mortgages Offer Odious Math for Homeowners

Danielle Park

Portfolio Manager and President of Venable Park Investment Counsel ( Ms Park is a financial analyst, attorney, finance author and regular guest on North American media. She is also the author of the best-selling myth-busting book "Juggling Dynamite: An insider's wisdom on money management, markets and wealth that lasts," and a popular daily financial blog:

North American households are some of the relatively wealthiest in the world, with 10% of the population having a net worth of $1 million US or more, mostly held in personal residences. On the other hand, 90% have a lot less than $1 million.  Seventy-five percent have less than $400,000, 50% less than $100,000 and 60% report having less than $1,000 in savings.  You can see a chart break down for Americans in 2016 and 2013 here.

After a 15-year above-average price expansion in real estate into 2017, Canadians have more paper wealth in housing than ever, mostly in the age 50+ cohort. This could be good news for an ageing population with otherwise insufficient retirement savings and little in the way of pension income.  If owners are able and willing, homes can be sold or downsized raising cash for living expenses.  A growing number, however, have been convinced they can keep their home and eat it too with the ‘help’ of a reverse mortgage.


The Office of the Superintendent of Financial Institutions (OSFI) which oversees federally regulated financial institutions and pension plans says that Canadians owed over $3.48 billion in reverse mortgage debt at the end of November 2018–a new record high, up 1.85% from October and 31.68% over November 2017.

The chart on the left, from Better Dwelling, is of reverse mortgage debt growth since 2012, see Canadian Reverse Mortgage Debt rises over 30%, sets new record.

Since no payments are made throughout the amortization of a reverse mortgage, interest compounds to the payout date, whether that be the owner’s death or such time as they may decide or need to move.  While compound interest is a great friend when it comes to building capital, it is our arch enemy when it comes to borrowing money.

A 55-year old, with a home valued at $1,000,000 can take a loan of $150,000 presently at rates of 6.24 to 6.74% on fixed terms of 6 months to 5 years, as shown here on the ‘Equitable Bank’ website,  In addition, upfront set up costs of 8 to 11% are deducted from the proceeds advanced.

If the loan is repaid at the end of 5 years, assuming an 8% set up cost and 6.74% fixed rate, the sum due would be $207,839 on $138,000 borrowed ($150,000 advance less 8% set-up fee of 12k), amounting to a compound interest rate of 8.53% a year, about twice current prime mortgage rates.

After ten years, assuming interest rates at the 5-year renewal have not risen but stayed at the present 6.74% level, the 138k advance (150-12k set up fee) would cost the borrower $149,980 in finance costs or 10.9% per year.

If the loan is outstanding for 20 years, using all the same assumptions, the cost of borrowing the 138K rises to $411,660 or a cost of 13.7% a year.

In extolling the ‘ease and convenience’ of compounding debt against one’s home at rates 2 and 3 times conventional mortgages, the reverse mortgage (RM) calculator here relies on two key assumptions:  first, that home prices will appreciate 3% a year over the loan term, and second, that loan rates will rise by no more than .25% every 5 years!!

After an extended, 15-year up-cycle in realty prices, with interest rates still near historic lows, neither of these assumptions may prove realistic.  Indeed, it’s entirely possible that home prices could remain flat and even decline over the next 5 or 10 years, and interest rates rise 2 percent or more. Of course, if this were to happen, the math for RM borrowers gets even more odious.

The worst scenario that the RM calculator will allow borrowers to contemplate is that interest rates rise 1% after each 5-year term going forward.  If this extremely modest increase were to happen,  then the interest cost of a 138K net advance today rises to 155K in 10 years (a rate 11.3% a year), and 604k after 20 years (21.9% a year!).

If home prices were to remain flat over the next 5 or 10 years, and interest rates rise just 1% at the end of each five-year-term, then home equity erodes much quicker than base case scenarios assume.

The most bearish scenario the calculator will allow is a home price decline of 5% a year during the term of a loan.  If that were to materialize, along with a 1% interest rate rise every five years, then the starting 1 million in home equity would reduce to 293K after ten years, and zero a few years after that.

A few concerns should be obvious here.  First, not everyone will want or be able to stay in their home until death, and should they need to move, they are likely to find that finance costs have consumed a lot or even all of their equity.  Since home equity makes up the lion share of most people’s net worth, this is no small matter.  This means much-reduced resources to fund old age care or leave for beneficiaries.

There may be a case where a reverse mortgage makes sense in unique circumstances.  In real life, I’ve not seen one.

As usual, the best course is not to sign up for high-fee financial products that promise we can extend and pretend higher spending than our stored capital can sustain, but rather to be pragmatic and proactive in managing our savings and net worth so that we waste less and benefit more.  For most people, this will mean downsizing real estate and living expenses sooner than later, as we approach retirement, and there is much solace to be gained in setting ourselves up on solid financial footings.

If someone you know is considering taking out a reverse mortgage, send them this article and suggest that they get a second opinion.

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January 25th, 2019

Posted In: Juggling Dynamite

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