By JIM PITT SPECIAL TO THE VOICE
A financial company with a vested interest in seniors' debt has published a study with some scary numbers. It begins, encouragingly, by stating that 9 out of 10 Canadians over 65 want to stay in their homes. It tells us that 8 out of 10 seniors have savings, but half of these savers have saved less than $100,000. Nearly the same number of seniors—77%—are going to rely on the Canada Pension Plan for an income, while 73% will also rely on the Old Age Security payment.
Combined, these two programs will pay you an average of $1,255 per month. If you have been a high earner, this might increase to $1,684 per month. Most seniors fall into the average category. Roughly 6 in 10 have RRSP’s, half have work pensions, and half have savings. On the debt side, seniors are increasingly breaking a time-tested rule and retiring with debt. Fifteen percent have a mortgage averaging $15,000; 2 in 10 have a line of credit, and 1 in 10 have car loans. Seniors are carrying another $15,500 in consumer debt. To make things even more difficult for retirees, company pension plans have been greatly modified over the last decade, more collateral damage from the 2008 financial crisis.
Today 9 in 10 private corporate pensions are defined contribution, while the public sector enjoys defined benefit pensions.
The differences are striking. In a defined contribution plan the employer matches any contribution you make. The funds usually end up with one of the corporate executives' relatives in a high-MER mutual fund and the earnings can be disappointing. MERs are the fees, or, “Management Expense Ratio,” charged by the fund. These rates can be very high—over 2% is common. If your fund has a return of 5%, you only see 3%. The rest goes to the fund managers and salesperson who sold it to you.
A defined benefit plan, the type that government workers, including teachers, tend to get, pays the retiree a fixed amount per month, which is inflation adjusted through cost of living adjustments. The private sector does not like these legacy debts and are ridding themselves of them at a breakneck speed.
With the stark reality that many will retire without enough money, the financial industry has risen to the challenge of trying to turn lemons in lemonade, and what a bitter brew it can be.
The financial company mentioned above, with a vested interest in indebted seniors, sells reverse mortgages. In fact it is the only company in Canada that sells reverse mortgages. That’s odd— why haven’t the big banks jumped on this? The name of their plan has a vaguely official sounding name, like a government sanctioned entity; it’s not.
This relatively new mortgage works like this. You own your home and it has an appraised value. You approach this company for a reverse mortgage or loan on your home. It agrees to lend you a percentage of the home’s value at the interest rate and term agreed to. You pay them an administration fee of $1,495 and you get the money.
Sounds pretty straightforward and in today's housing market there are many wealthy homeowners, at least on paper. Their houses, especially in the GTA, could be worth over a million dollars. Their monthly income could be very low, especially if they are solely reliant on government pensions, and day-to-day costs are rising.
If you are over 55, this company will lend you up to 55% of the value of your home. You can have this money as a lump sum or in equal payments. There is no tax on this money and you don’t have to declare it as income. You never have to pay it back, so long as you stay in the house. You may use the money to renovate, travel, pay off debts, invest or give to your children.
However, while you are out strolling on an Italian beach or bankrolling your kid’s independent film production, this loan will devour your house and use the framing to clean its teeth.
To find out how they work, I applied for one of these loans. A nice young salesperson told me the following. Because of my age I could only get 22% of my home's value as a loan. He assured me I could get the house reappraised every 2 years and apply for more. These loans are 5-year terms only, and you must renew when the term is up. They are aimed more at the 70-plus age group. He said most borrowers use the money as a safety net.
Like any loan, you pay fees and interest on the amount borrowed. The fees can be up to $10,000 for things like land transfer tax, appraisal of the house, title insurance, home inspection, and required legal advice. In the case of reverse mortgages, rates are twice as high as a regular mortgage.
Imagine the carnage if standard mortgages were currently at 5.22% to 5.63%. Some 75% of mortgage holders would be in trouble if rates went up just one percent from their present low rate.
The longer the term of the reverse mortgage (as with any loan), the more debt accrues. A $200,000 loan over 10 years grows to $336,700. Over 20 years, $566,900, and over 25 years, $735,500.
When you sell or otherwise leave your home, this money is due. This type of mortgage effectively traps you in your house. Your kids will get nothing and could be left with a complicated mess.
If you have second thoughts at any point and want out of this deal there are the usual penalties associated with exiting a mortgage early and they are expensive.
That said, this type of mortgage can work in very specific cases. If you have no heirs, are 70-plus, and plan on leaving your home on a gurney, then go for it. No one knows our recall date, so even this is a gamble.
If you need long-term care or want to move to a retirement residence at some point, the reverse mortgage will leave you without any equity, and your only income will be whatever pension money you have coming in. There are some alternatives though.
If your house is currently worth a small fortune, you’ve won the lottery. Sell it, invest the winnings, and rent. The income from the investments will pay your rent, so you’ll live for free.
If you sold your house for $500,000, invested and averaged a conservative 5.0% annual return, based on an annual inflation rate of 2.5%, withdrew $2,000 per month, after 20 years you would still have $326,000. Not bad, and hey, you lived virtually free for 20 years.
Renting has a bad reputation in Canada. Outside of the English-speaking world renting is very common. In fact a majority of people rent because housing is too expensive to buy. Many wealthy people rent, sometimes even senior municipal officials, so it can’t be all that bad (plus it makes getting out of Dodge a heck of a lot faster).
If you want to keep the house, you could get an interest-only HELOC (Home Equity Line of Credit). A $200,000 loan here would cost $533 per month at 3.20%. Pay this monthly and when you sell the house, pay off the principal and pocket the rest. You would still have $300,000 if your house was sold for $500,000. This type of loan requires an adequate income for you to qualify.
You could also sell the home to your kids on condition that you stay on in a suite, but you have to really trust your kids, one of which is already ill-advisingly making an independent film.
You could rent out part of your home, but this has tax implications when you sell. The part you rented is disqualified from your Primary Residence Exemption and capital gains are added to your marginal tax rate for the difference.
Bottom line, a reverse mortgage is the last alternative for someone in need of cash flow. There are other ways, with the best being to save for retirement. More on this to come.
