How Reverse Mortgages Work

Jul. 28

The attached garage of a pink-cream house. There are two garage doors, one double-wide. The second floor of the house can be seen peeking up above the garage. It's a sunny day with deep blue sky.

What is a Reverse Mortgage?

A Reverse Mortgage allows a homeowner to access equity in their home while living in it. Their home equity is used as collateral for a loan where, in some cases, the loan principle and interest becomes due on the homeowner’s death, or sooner if the individual sells their home. The minimum age is 62 and the loan value ranges between 10% – 40% of the appraised value of their home.

There are 3 Common Types of Reverse Mortgages:

Reverse Annuity Mortgage

Comprised of 2 parts:

A mortgage
An annuity

The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds are used to purchase an annuity which pays the homeowner a monthly income for the rest of their life.

The repayment of the loan is due at the time of the homeowner’s death, or sooner if they sell the home.

Line of Credit Reverse Mortgage

The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds are used to create a line of credit which the homeowner can borrow from when needed.

Debt repayment commences when the money is withdrawn from the line of credit. This type of plan is valuable for people who require money at specific times and not on a regular basis.

Fixed Term Mortgage

The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds provide the homeowner with cash flow for a specific period of time, usually 5 to 10 years.

The repayment of the loan occurs at the end of the fixed term. This is valuable for people who require cash flow on a regular basis for a short period of time.

Taxation?

Simple reverse mortgages and lines of credit are not tax-deductible since they are similar to a loan advance from a traditional mortgage.

When reverse mortgages are used for investment purposes the accruing mortgage interest is tax-deductible against any investment returns generated with the mortgage proceeds, providing individuals with tax-sheltered income.

While annuity income is taxable, annuity income generated from a reverse mortgage is not taxable.

*** Please note that a Reverse Mortgage may not be the ideal plan for everyone. There are certainly pros and cons, but for some people, it can be a feasible way to augment retirement income.