October 17, 2019 | Tools

The moister moaning has been munificent over the past months since the stress test came along. Maybe 20% of buyers have been punted. And rightly so. People without enough money shouldn’t buying houses.

But what about the wrinklies? They’re the crusty folks Mills love to hate – the ones who bought years ago and now sit on towering piles of windfall equity. However, the stress test may be taking a toll here, too. When house-rich, cash-poor people head into retirement with chopped income they face a choice: sell the house and disrupt life, or borrow against it to buy kibble and edibles.

The trouble? With lousy cash flow they can’t pass the stress test. Nor will the banks hand them HELOCs, now that lending requirements have been stiffened. So what happens?

Yup, reverse mortgages. They’ve exploded since the stress test arrived. Just shy of $4 billion is now owed, and the total’s grown by more than 26% in just 12 months. Staggering. Especially when you consider this money is being borrowed at the rate of  5.86% – or twice the cost of a conventional mortgage.

To refresh your memory, a reverse mortgage allows people in their fifties and beyond to borrow a whack of money against their home equity. The cash comes in a lump sum or through regular payments. There are no repayments involved, no tax on the income and the money is only returned to the lender when you sell or croak. That makes it a seductive vehicle for those who don’t want to move and lack the dough to live on. No wonder such growth is happening.

But there’s a downside. A big one. Reverse mortgages cost a lot, and the high interest rate means the outstanding balance grows every month. Fast. After a few years you can owe a lot more than you borrowed, wiping out equity and robbing your estate (and those sad, Millennial inheritors). So as a retirement plan this costs a bundle, compared with selling the property, investing and living off the income stream while retaining capital.

So why would anyone do it?

Let me share an email from a long-time mortgage broker, answering exactly that question:

The stress test has had the biggest impact to Canadians approaching retirement.  In the case of retirees, the test could be deemed discriminatory in the sense that the increased qualifying criteria impacts a retiree the most when their income decreases when transitioning from pre-retirement to retirement.

Traditional banks are not kind to seniors with abbreviated incomes.  Line of credits are no longer an option since the qualification for them have become harder.  Reduced income scenarios coupled with the stress test for a line of credit (amortized calculation) product make it impossible to access for seniors.

As seniors live longer and want to maintain the same living arrangements due to familiarity of neighbourhoods and homes, the reverse mortgage acts as the only option without a payment obligation.  We cannot be surprised with the growth of the product as wealth planners are now using this product as a tool to manage their golden years.

Well, mortgage dude, this wealth planner’s not buying it. A reverse mortgage is expensive, costly to set up, subject to rising rates, equity-sucking and at the very bottom of the tool chest, down there with the corroded AAA batteries and dead stink bugs. There are far better options.

And consider this strategy, from the same broker:

We recently saw a client with a $3,000,000+ home utilize the product to advance $1.1 million and used the proceeds to purchase thee condominiums (to eventually pass down to  each of his three children at some point) and they are all cash flow positive and he gets to write off the interest against the rental income.  The product has become a wealth planning tool.

This undiversified senior was talked into buying three more properties with leverage at twice the rate of a conventional mortgage to secure a trickle of income, fully-taxable, plus deductible interest. Will his three kids want used condos in a few years in a taxable deemed disposition? How is ending up with four properties instead of one an example of de-risking? Does an old retired guy really want to be an amateur landlord, fishing iguanas out of the toilet and scraping mold off the grow-op room floor? Would it not be better having a cash flow-producing portfolio of lowly-taxed dividends and cap gains? Isn’t it better for ‘wealth planning’ to have a balanced approach instead of putting all the eggs in one (real estate) basket plus shoveling on debt?

This is why mortgage brokers are not financial advisors. And sorry about that $4 billion in inheritance, kids. Bummer.

Garth Turner October 17th, 2019

Posted In: The Greater Fool

Next: Resource Constraints Driving Unrest and Evolution »