Globe and Mail reporter John Heinzl.The Globe and Mail
I'm one of those people who is house rich but cash poor. What's the best way to tap the equity I have in my home if I need the money in retirement?
With home prices soaring in recent years, folks who haven't saved adequately to fund their retirement years are looking to the roof over their heads as a potential source of cash. If you've paid off your home or built up a substantial amount of equity, there are various ways to unlock that value.
One obvious solution is to sell the home and downsize to a smaller house, condo or retirement facility. Particularly in hot markets such as Vancouver or Toronto, downsizing or renting is an option to consider, says Derek Moran, a fee-for-service registered financial planner in Kelowna, B.C.
"If those markets correct, which I think is inevitable, my guess is these people are going to regret not selling when things were really high," says Mr. Moran, president of Smarter Financial Planning.
For retirees who want to remain in their current home but are facing a cash squeeze, there are two potential solutions: a reverse mortgage, or a home-equity line of credit. Each has its own pros and cons.
The main advantage of a reverse mortgage is flexibility: Once you get your money – either as a lump sum or advanced in stages – no principal or interest payments are required. HomEquity Bank, which administers the CHIP Reverse Mortgage Plan, will lend up to 55 per cent of the value of the home, depending on factors including your age, as well as the value and location of the property. The loan doesn't come due until you die, move or sell, but you are required to maintain your home and pay your property taxes and insurance so that the lender's security is not impaired.
The main drawback of a reverse mortgage is the high cost. A five-year fixed CHIP reverse mortgage, for instance, currently has an interest rate of 5.99 per cent (excluding closing and administrative costs of $1,795). That's about double the lowest rate available on a conventional five-year fixed mortgage.
Because most people choose not to make interest payments with a reverse mortgage, the loan balance can rise dramatically over time. For example, a $250,000 loan would grow to $451,000 after 10 years, based on an interest rate of 5.99 per cent compounded semi-annually. So you pay a steep price for the freedom from monthly payments that a reverse mortgage provides.
A less expensive option is a home equity line of credit, or HELOC, which typically lets you borrow up to 65 per cent of the value of your home. According to ratehub.ca, the cheapest HELOCs currently charge 3.7 per cent (prime, plus 0.5 percentage points). Another advantage of a HELOC is that you can use it only as needed – you aren't required to draw an initial lump sum or take regular payments.
"Maybe, every once in a while you need to replace a vehicle, so you have the flexibility to do that," says Talbot Stevens, a financial industry consultant and author of The Smart Debt Coach.
One big downside of a HELOC – particularly for retirees who are having trouble making ends meet – is that it requires monthly interest payments for the loan to remain in good standing. So, unlike with a reverse mortgage, you can't just let the interest accrue. What's more, HELOCs charge a variable interest rate, which exposes the homeowner to higher costs if rates rise, as they've been doing recently.
Mr. Stevens points out another drawback of HELOCs: If you wait until you retire to apply, you might not get approved for the loan. That's because lenders take your income into account, which might be too low in retirement to qualify for a credit line. One potential way around that would be to arrange the credit line before you retire.
However, if down the road, you're unable to make the interest payments for any reason – or if the bank decides to call the loan because your credit is deteriorating – it's possible that you could be forced to sell your home. That's why, in addition to financial considerations, the decision to go with a reverse mortgage or HELOC also depends on "how comfortable you are with uncertainty," Mr. Stevens says.
John Heinzl