When an older retired client wants to continue living in the family home, there are options. He or she could consider a home-equity line of credit or a reverse mortgage.
Both ensure income in the golden years and may provide opportunities for reducing taxes. But there are differences, and anyone venturing in that direction should understand the implications.

“For seniors, the biggest issue is after-tax cash flow,” says Steve Ranson, president and
CEO of the Canadian Home Income Plan, the Toronto-based private company that arranges reverse mortgages in partnership with most Canadian chartered banks and credit unions, as well as with a number of investment firms and mortgage brokers.

Available in Canada to people 62 years of age or older who own their homes outright, reverse mortgages provide holders with lump-sum payments based on the equity in their principal residences. The homeowner can borrow 10%-40% of the home’s appraised value to a maximum of $500,000, based on age, gender and life expectancy.

Mortgage holders can take all the money they’re entitled to up front, or take a minimum of $25,000 and the rest as needed. They can use the money for whatever they want. If they use it for living expenses, the payouts are tax-free income. If they invest the money, they can realize several tax benefits. The payout can be used to:

> Generate tax-sheltered investment income. As with all loans taken for investment purposes, the interest that accrues on the reverse mortgage is tax-deductible if the money is invested. Canadian investments that pay dividends also provide the Canadian dividend tax credit.

> Maximize rrsps. At age 69, seniors have to convert their RRSPs into RRIFs. But they may still have a lot of unused RRSP room. “With the payout from a reverse mortgage, they can top up their RRSPs,” says Ranson. “They’ll gain the RRSP tax deduction without the burden of RRSP loan payments, and these deductions will reduce the taxes they pay and their exposure to old-age security clawbacks.”

Canadians older than 69 can still use unused RRSP room in a spousal RRSP if their spouse is younger than 69. And because calculation of the current year’s RRSP contribution is based on the previous year’s salary, a final contribution can be made the year the senior turns 69, enabling the client to put more money into the tax-deferred account.

> Make the most of rrifs. Seniors may consider taking money out of RRIFs to cover living expenses. Say Ranson: “We suggest leaving the money in the RRIF, letting it compound tax-free and living off income from a reverse mortgage.”

However, critics of reverse mortgages say that their costs can outweigh the advantages.

For example, the interest payments on a reverse mortgage can be delayed until the mortgage principal is repaid or the estate settles the loan upon the homeowner’s death.
But holders pay a premium for this privilege, says Carien Jutting, president of the Canadian Association of Pre-Retirement Planners and president of Fiscal Wellness in Stratford, Ont.

CHIP’s rates are based on six-month, one-year or three-year terms. The six-month rate was recently 6.8%; the one-year rate, 7.25%; and the three-year rate, 7.5%; interest is compounded semi-annually. CHIP gives discounts after three years; for all three terms, the reset rate is discounted by 0.25%, and will be discounted an additional 0.25% each year to a maximum of 1.5%.

Jutting notes that the high compound interest bill will eventually have to be paid. “It’s mind-boggling how this adds up,” she says. “The worst-case scenario is the estate will be depleted and the heirs will have bills to pay.

“The fact that you have to get independent legal advice when you apply for a reverse mortgage is a clue someone may have reservations down the road,” she adds. CHIP requires potential clients have their lawyer review the reverse mortgage contract.

Some homeowners may consider lines of credit as an alternative. Author Graham McWaters of Richmond Hill, Ont., who wrote The Canadian Retirement Guide (Insomniac Press, 2004) and is a specialist in real estate-secured lending at TD Canada Trust, says most banks charge the prime rate — recently 4.5% — on home-equity lines of credit. “The payout can be used to invest and reduce taxes, and you’re paying simple, not compound, interest,” he adds.

@page_break@The cost of setting up a reverse mortgage is usually higher than setting up a HELOC.
With reverse mortgages, a home appraisal has to be made, costing from $200 to $350 in major cities. CHIP’s closing costs and administrative fees are $1,285. On its Web site, CHIP says lawyers’ fees to review the mortgage contract will be $300-$700.

McWaters says the cost of setting up a HELOC varies from bank to bank. The bank can charge appraisal fees, fees for a title search and fees to prepare and register legal documents. Different banks may take different approaches to getting a title search.
Title insurance firms will do this for a flat fee of about $400, while lawyers will charge $500-$1,000. Some banks may cover all or part of the appraisal and/or legal fees as part of a promotion.

As well, a reverse mortgage must be registered as a first mortgage, while HELOCs can be second or third mortgages.

Another important difference is that the owner must live in the home to qualify for a reverse mortgage, while HELOCs can be obtained on rental property. “The owner can be living in a nursing home, the home can be rented, and the rent and the HELOC payout used to generate investment income,” McWaters says.

The downside of HELOCs is they require regular interest payments. And banks look at income level, among other factors, in assessing an HELOC application. Income is not a factor in getting a reverse mortgage.

Further, with a line of credit, the homeowner may be asked at some point to sell the home to settle the debt. A reverse mortgage, on the other hand, is a lifetime loan.
However, holders of reverse mortgages will face prepayment penalties if they cancel after being in the program less than 36 months. HELOCs carry no discharge penalties.

“There are better ways to obtain money than reverse mortgages,” says Marie Howes, a financial planner at Moneysmart Inc. in Mississauga, Ont. “A client can sell, move to cheaper accommodation and buy an annuity with the excess.” IE