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Real Estate Wealth

What is the True Cost of a Reverse Mortgage?

If you own your home (i.e. mortgage free) and over age 60, you’ve likely seen ads for reverse mortgages. A 30 second ad can make a reverse mortgage appealing, however you must consider the true cost.

Note: For reference I’ve posted a couple ads below:

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Essentially, a reverse mortgage is a loan (using your house as security) on which you don’t have to make re-payments. Instead, any interest accrued on the loan simply gets added to the principal. While the thought of not making payments can sound enticing, a reverse mortgage can be one of the more expensive ways to access money in retirement.

People get reverse mortgages to access the equity in their homes to pay off debt (including a pre-existing mortgage), cover medical expenses or make home modifications. Many use a reverse mortgage – as opposed to other forms of debt – because they don’t have to make payments until they (or their estate) sell their house. This frees up cash-flow. Homeowners are still expected to maintain the property and pay all property taxes and insurance costs, or risk foreclosure.

Before using a reverse mortgage, people must be aware of the total costs. I believe there are usually better alternatives.

First of all, the interest rates on reverse mortgages tend to be higher than conventional mortgages. Home Equity Bank sells the CHIP Reverse Mortgage and provides a bar chart that compares loan rates below. Based on the information they provide, the interest rate on reverse mortgages tends to be about double that of conventional mortgages, but cheaper than unsecured loans, credit cards, etc.

I frequently say reverse mortgages are expensive, but I’ll admit they’re still cheaper than some alternative forms of borrowing. However, there is more to the total cost than the interest rate alone.

Since you’re not making interest or principal payments on the loan, interest expenses get added to the principal. This is what really drives the cost of a reverse mortgage.

Effectively, as the mortgage compounds you pay interest on interest. In other words, the amount you owe grows at an exponential rate over time. The table below – again provided by Home Equity Bank – shows how a $150,000 loan becomes $204,939 in only five years at a 6.34% mortgage rate.

If we extend that scenario to ten years, the total amount owed becomes $282,299. That’s almost double the amount of cash originally received when the loan was originated.

The CHIP Reverse Mortgage allows homeowners to access up to 55% of the value of their house. So let’s imagine you’re sitting on a fully paid-off houses in Toronto worth $909,090. Using a CHIP reverse mortgage you can borrow $500,000. As you can see in the graphic below, in ten years, you owe $940,996 – more than the value of your home when you took out the loan.

Of course, during the decade the value of your home might also rise, in which case you would still have positive equity. Regardless, in the end you’re paying $1.82 back for every dollar you borrowed. As you can see, the cost of a reverse mortgage is almost equal to the amount of the original loan.

Some borrowers might not be bothered by this – in the end it’s not their loan to repay. At death, the estate will sell the house, repay the reverse mortgage and whatever’s left over will go to the deceased person’s heirs.

However, the family unit might not want to sacrifice a million-dollar asset in exchange for $500,000, while praying the house appreciates in value over time so there’s something left over. Despite the experience in Canada over the past couple decades, housing prices don’t always rise – just ask someone who owned a Toronto home in the 1990s.

A fully paid-off house represents your lifetime of sacrifice and effort. To swap it for half its value and hope to get something in the end is a waste and a gamble, in my opinion. While history has shown that real estate prices keep up with inflation, this should not be the expectation when getting a reverse mortgage. In my opinion, any form of borrowing should be made under the most conservative assumptions.

If you or anyone you know is considering a reverse mortgage, PLEASE be aware of the true costs. Get the family together and consider whether it makes more sense for other family members to help cover retirement expenses to help preserve ownership of the house within the family. If you must borrow, consider using a more conventional loan that gets repaid over time. This will help avoid the costs of compounding.

If there are no other alternatives consider selling the house.

In this case you’d get $909,090 today. (For simplicity’s sake, I’m not considering transaction costs of either selling or entering the mortgage.) The $500,000 could be used to fund retirement costs. The remaining $409,090 could be invested and withdrawn to pay for an apartment. If your investments earned 5% and you withdrew $2,000 per month for an apartment you’d still have $361,917 after ten years. Would you have this much in equity in your house in ten years? Maybe. Maybe not. The thing is the liability is a sure thing, the asset price is not. Of course, the value of the portfolio isn’t a sure thing either. However, it is liquid and that has value.

Finally, I think it could be a great idea to use the $409,090 to purchase a larger house so you can live with the rest of your family. The money then remains in the family (as opposed to paying rent to an outsider) and everyone is together.

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Real Estate

What You Need to Know Before Buying a Home

Buying a home costs a lot of time, effort and money. Unfortunately, many things can go wrong.

I recently came across a Reddit thread in which people shared their tips for home buyers and new homeowners.

Here are some of the best tips:

  1. Doing a bit of maintenance every year is extremely important, regardless of what type of home you buy, and do your research before you hire any contractors for any maintenance/reno work, so that you will at least have a basic understanding of what they are supposed to be doing, because they will cut corners and/or miss things, and you have to watch them like hawks and let them know that you know what they are supposed to be doing. Always get quotes before you start any work and never give them a downpayment as any reliable contractor will not need one.
  2. Also take pictures of the work area before and after they arrive, for insurance purposes and in-case they damage anything so that you have it documented. Also, never lie to your insurance company or ‘forget’ to tell them something as that is automatically used to void any claims you may have/had.
  3. If there is any non-tile flooring in the house, and not carpet, ask the seller what type it is and see if you can still buy any spares. Flooring manufacturers intentionally stop making models a few years after inception so that when boards crack or get stained or chipped or whatever, you have to replace the entire floor to keep everything matching, so if you have floor that is vinyl or laminate or engineered wood or whatever, see if you can still buy spares; trust me, you will really prefer the small investment now to replacing the entire floor later on.
  4. Ask other owners in the building (if it’s a condo) if the building has problems with leaks, and with condensation, as they are really expensive to deal with and are driving up building and unit insurance rates (at least in Ontario), and if the building has a problem with condensation then it can cost you thousands of dollars to repair if your unit is deemed to have been the cause of it.
  5. The home inspector should catch this, but check that all of the circuit breakers actually do what their labels say that they do, as if they don’t, this is a bright red warning sign of a bad wiring job, and probably means that they did a bad job in other ways too, which won’t just be expensive, but could be a fire hazard as well. If you can, try a few of the outlets too, to make sure that they are working (often they aren’t, or only one will work at a time if they are stacked), and to see if they get hot quickly, as this is another sign of a bad wiring job, but again, the home inspector should definitely check this.
  6. If it is a condo, read all of the Condo board’s documentation, as different buildings have different definitions of what is considered ‘commons’ responsibility’ and what is considered the unit owners responsibility, and that especially goes for pipes/plumbing. The condo documents should clearly state where your responsibility starts and ends, and you need to know this because if something goes wrong (burst pipe that leaks into the unit below), they absolutely will not tell you that actually on page 48 it states that toilet pipes inside the walls are actually common elements and not your responsibility, they’ll just bill you and hope you don’t catch it.
  7. Don’t make an unconditional offer that you can’t or won’t honor. If the seller accepts it, and then you pull out, and the owner sells the property to someone else for below the price you were offering, they can and will sue you for the difference, and most likely will win. If you do include conditions, make sure that they protect you and are reasonable for the other party to fulfill, and expect that they will be fulfilled, otherwise you can get into an ugly dispute with them if you then want to try and back out on account of the conditions not having been fulfilled.
  8. Don’t buy a fixer upper unless you have the cash and time to fix it up before you move in. You will just live in a constant Reno house for years.
  9. Get the sewer line scoped. Find the inspector yourself not through the realtor – check wiring, electrical boxes/panel, crawl space insulation/vapour barrier. Make sure you test each light switch to know what it does and that it is working. If it has fireplace make sure it is WETT inspected, up to code etc.
  10. Remember that the most costly expenses are to the things that you can’t typically see… wiring, plumbing, sewer lines etc. Be sure to run the hot and cold water lines independently in each room then go to the basement and listen. You may hear something out of the normal; hammering, drips etc. Same goes for running the washing machine and checking that the sump pump operates (if it has one)… it can all be a bit overwhelming at times, but it will help you better understand what might be an issue that you’ll need to address in the future… and be prepared to negotiate. The furnace in the house we bought was 20 years old, so we negotiated a percentage to replace based on typical life span, same for the sewer line… your diligence might lose you the house depending on market conditions, but will save you a whole lot of hurt down the road… and remember, three quotes for any work that you need to have done… and make decisions based on level of detail provided in the quotes and checking references/reviews… it is YOUR money and you CHOOSE how to best spend it and you can only do that with information/data… emotions are not your friend 🙂
  11. Get the inspector to actually go up on the roof to inspect it. Ours just looked from the ground and missed that the flashing was not done properly. We had the surprise of a leaking roof when we replaced the windows before moving in and had to redo the roof there and then. I tell you, its not fun having to find an extra 10k when you put all your free money in downpayment, closing costs and planned pre-move-in repairs/renos. Many inspectors are older and refuse to go up on roofs. Find the thorough ones.
  12. Visit the neighbourhood different times of the day. Do the commute to/from work to see how it is. Make sure you can put aside money for an emergency repair. Plan to replace any rental hot water heater (I have no idea why those are still a thing).
  13. Don’t rush into furnishing your home. Many homeowners tend to go all out and buy everything they can to fill every nook and cranny. Yes it’s hard to see your new home empty or filled with old second hand furniture. Furnish as you go and start with the rooms you use on a regular basis. You WILL find deals and things that fit the rooms style or need, just be patient!
  14. What the bank says they’re willing to lend you is NOT the same as “what you can afford”. Figure out what $ of mortgage you are willing to pay and how much downpayment you can put down, and ask your broker what that translates to in terms of house price. Also factor in insurance, upkeep, maintenance, repairs, replacements, move in costs, furnishings, etc etc. You do not want to be “house poor”. Live in a decent house, but can’t afford to pay for anything else. A few of my friends fell into this trap and regret it every single day.
  15. If you buy an older house try to budget for a new furnace, hot water tank and attic insulation.
  16. Always have money on the side for emergencies. After 4 years of owning my condo townhouse the condo board decided to replace all windows at owners expense, I was given 6 months to cough up $7,800.
  17. On my next house, I was excited to not live in a condo anymore. I had bought a bungalow. 1 year after purchase the french drain was at end of life and water started seeping into my basement. The insurance company paid for 2 sides of the houses french drain replacement. I made the tough decision to pay out of pocket for the remaining 2 sides. It amounted to $11,000.
  18. There will always be big budget unexpected expenses. Have some money on the side to be able to cover them.
  19. Make sure you want to stay there for 5-10 years. Unless it’s extenuating market circumstances, I like the 5 year rule for housing. You’ll never make money off a sale until you’ve possessed it for 5 years.
Categories
Real Estate

Chart: Home Insurance Costs by Ontario City

Are you paying a fair price for home insurance in Ontario? Home insurance rates vary by city. For example, home insurance in Toronto costs about twice that in Cambridge.

With little information out there, home owners and home buyers are often left in the dark when pricing out insurance costs. The last time I had to get home insurance I had no basis for comparison. So I had to spend hours on the phone with multiple providers to get quotes.

Luckily, Zoocasa did the legwork and provides average home insurance costs by city across Ontario.

Source: DumbWealth, Zoocasa