Asset rich and cash poor is a situation in which some people find themselves. Often, the family home is the cause of this dilemma. Seniors, in particular, can fall victim to having insufficient pension and investment income to keep up with inflation; yet, the home that they have owned for decades is worth a substantial amount.
A “reverse mortgage” is a financing scheme that attempts to solve this dilemna. The Canadian Home Income Plan (“CHIP“) Corporation will take a mortgage on your home in exchange for an income stream for life. No mortgage payments are made during your lifetime. Upon your death, the principal and accumulated interest is paid out of your estate. The house does not have to be sold. If your beneficiaries wish to retain the house, the mortgage can be paid out from other assets in the estate.
Unlike conventional lenders, CHIP will not mortgage up to 75% of value. The proportion will vary from case to case. The proceeds are used to purchase a life annuity; however, you may elect to receive up to 35% of the proceeds in cash. The balance would be used to purchase a smaller life annuity. As with other annuities, you must decide between a straight life annuity and a “term-certain” annuity.
An unusual and valuable twist is that Revenue Canada has concluded that the annuity income is tax-free. Also, the income would not affect any supplementary entitlements, like “GAIN” or GST credits. Note that, if you take a portion of the proceeds as cash and invest it, you would lose the tax-free status of that investment income. In other words, it is wiser to take cash proceeds only if you need funds immediately for a particular purpose, eg a new car.
You may pay off the mortgage at any time; however, the annuity cannot be undone and will continue for life (and/or the term-certain period). Note that the tax-free status of the annuity would cease if the mortgage was paid off. Remember that you are entering into two transactions here; you are borrowing money and you are investing in an annuity. Each transaction has its own interest rate. The annuity rate is a market rate at the time you sign up and that rate lasts until your death. The mortgage rate is a market rate at the time you sign up but is renewed every fifth year. Thus, you bear some risk that your rate of borrowing may one day significantly exceed your investment rate. This risk may be greater when rates are at historical lows.Remember, however, that you do have the right to pay off the mortgage.
If your house value increases, you may apply for a larger mortgage and annuity on the five year anniversaries. You may also transfer the mortgage to a new house if you move. If the accumulated mortgage exceeds the value of your house upon sale, you do not have to make up the difference. The loss is absorbed by the CHIP funders.
A reverse mortgage is not for everyone. CHIP requires that you are at least age 60 and that your home is in a specified metropolitan area. Also, a reverse mortgage will reduce the value of your estate
for your heirs.
We have already assisted clients in placing reverse mortgages on their homes. We also have supplementary reading material. Please call us if you would like more information.