Ready to retire, loaded with debt

Use reverse mortgages only as a very last resort

Are retirees playing with fire? They could be if they decide to use money borrowed through a mortgage to supplement their other sources of retirement income. The most common ways those at or close to retirement do this is to hold a mortgage through their Locked-in Retirement Account (LIRA) or to borrow money against their home through a so-called “reverse mortgage.” But retirees should think long and hard before entering into either of these arrangements.

Those who have an employee pension plan and who are ready to retire often roll over their pension into a self-directed LIRA. Because they can invest their funds in pretty much the same qualified investments as an RRSP, some retirees decide to hold their own personal mortgage in the plan. The theory is that you take out a mortgage on real estate you own, and use the funds in whatever way you wish. You then pay yourself back through the locked-in plan.

Provincial regulations govern the administration of LIRAs. Each province has slight variations. In Ontario, a LIRA that holds your personal mortgage must be administered at arm’s-length from you, and must be insured (the Canada Mortgage and Housing Corporation and GE Capital are two widely accepted mortgage insurers). The interest rate must be set at rates generally available in the open market. If you default on mortgage payments, the mortgage administrator may foreclose, just like any other mortgage, so it’s important to continue making payments – even though it’s “your own” mortgage.

So the big question is whether you will have the cash flow to make those mortgage payments every month. You’re paying yourself in one sense, but in another sense, it’s out of your hands. This strategy may be useful for certain high net worth individuals who want access to cash from locked-in accounts for business or investment purposes as part of a more complex financial plan. For most retirees or pre-retirees, though, it’s probably not the right option.

Another increasingly popular option is the reverse mortgage. With the costs of “downsizing” (which often involves simply trading a larger home for a smaller home or condo at the same price with nothing left over) and the out-of-reach rents in most urban areas, some retirees are resorting to these types of mortgages to supplement their retirement cash flow.

The model is fairly simple. Retirees age 55 or older may be able to borrow up to 55% of the value of their principal residence in the form of a deferred interest-type of mortgage, provided the property is free of any other loans, such as existing mortgages or home equity lines of credit. The idea is that you get the funds tax-free immediately, either as a lump sum or as regular payments or some combination of both, but you won’t have to make any payments on the loan until it becomes due, and that’s usually when you sell the home. At that point you must repay the principal and all of the accrued interest over the period, generally from the proceeds of the sale of the home.

At present, only two Canadian financial institutions offer reverse mortgages: HomeEquity Bank, which offers the highly marketed Canadian Home Income Plan (CHIP), and Equitable Bank, which offers the PATH Home Plan in Alberta, B.C., and Ontario.

It sounds attractive on the surface. However, reverse mortgages typically carry a higher interest rate than conventional ones. And you still have to pay appraisal, setup, and legal fees. There are also prepayment penalties if you later decide to pay off the reverse mortgage before it’s due. The final catch is the “accrual” part of the equation. All that interest on the mortgage keeps collecting and is added to the amount of the original loan. The longer the period of the loan, the bigger it gets. And that has the effect of reducing the equity in your home (and your estate) when it comes time to sell and repay the mortgage.

Holding a mortgage in a LIRA or using a reverse mortgage are expensive and complicated ways to supplement retirement income and should be used only after careful discussion with your financial advisors. As a rule, retirees should be very wary about taking on large debts like this in retirement before exhausting all other options.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.