Posted On Jan 06, 2025

When it comes to financing care in retirement, particularly for those with limited liquid savings, reverse mortgages often get a bad rap. During recent conversations over the holidays, I noticed a prevailing sentiment: reverse mortgages are inherently bad and exploit homeowners with excessive interest costs. But is this perception accurate? Let’s take a closer look at a real-world comparison to shed light on the facts and help dispel these myths.

The Scenarios: Selling vs. Aging in Place

Imagine two individuals, both 65 years old, living in Toronto with mortgage-free homes valued at $1,000,000 but little to no savings. Each faces the challenge of financing care in their later years. Here’s how their financial journeys unfold under two different approaches:

Scenario 1: Selling the Home and Moving to a Retirement Residence

  • Action: The individual sells their home.  Since it’s their principal residence their sale is exempt from capital gains tax.  Real estate transaction fees such as agent commissions (typically 4-5%) and legal costs would reduce the net proceeds to less than $1,000,000, leaving less available for investment and potentially exacerbating the deficit.

  • Financial Plan: The $1,000,000 sale proceeds are placed in a combination of savings accounts and GICs earning an average of 3% annual interest, with taxes of 20% applied to the interest income. The 3% rate reflects a conservative estimate of returns from GICs available in today's market. 

  • Living Arrangement: They move into a retirement home costing $7,600 per month. This figure reflects the average cost of retirement home living in the Greater Toronto Area, which typically includes accommodations, meals, and basic care services (as reported in recent surveys of senior living facilities)

Outcome:

After 20 years of paying for the retirement home, the funds are completely depleted. In fact, the individual ends up with a deficit of $722,839, meaning they would run out of money long before reaching age 85, leaving nothing for their estate.

Scenario 2: Aging in Place with a Reverse Mortgage

  • Action: The individual takes out a reverse mortgage as a line of credit (HELOC) with a maximum limit of $430,000, drawing only as needed to pay for in-home care.

  • Financial Plan: The HELOC accrues interest at 8% annually on the outstanding balance. Meanwhile, the home’s value appreciates at 4% per year.

  • Living Arrangement: They remain in their home and receive in-home care costing $1,500/month for the first 10 years and $3,000/month for the next 10 years. This difference reflects the increased level of care often required as individuals age, such as additional nursing hours, assistance with daily activities, or more frequent visits by caregivers.

Outcome:

By age 85, the reverse mortgage outstanding balance has grown to cover all care costs, but the home’s value has also increased significantly. After repaying the reverse mortgage, the estate retains $1,019,891, leaving a substantial inheritance.

The Comparison: Debunking the Myths

1. “Reverse Mortgages Are Too Costly Due to High Interest Rates”

It’s true that reverse mortgages come with interest costs. However, in the scenario above, the home’s appreciation more than offsets these costs. By taking advantage of the home’s equity, the individual ensures they can cover care costs while still leaving a valuable estate.

2. “Selling Your Home Is Always the Better Option”

While selling the home provides immediate liquidity, it can result in financial depletion, especially if retirement home costs exceed the interest income earned on the proceeds. Scenario 1 demonstrates how quickly funds can run out, leaving no safety net or legacy for heirs.

3. “Reverse Mortgages Take Away Your Home”

This myth is perhaps the most misleading. With a reverse mortgage, homeowners retain ownership of their property. They are not forced to sell, and the estate repays the balance upon the homeowner’s passing or sale of the home. Meanwhile, the homeowner enjoys the comfort and stability of aging in place.

Why Aging in Place Makes Sense

For many, the emotional and psychological benefits of staying in a familiar environment are invaluable. Aging in place allows individuals to maintain their independence and community ties while leveraging their home’s equity strategically. The reverse mortgage option also provides flexibility, as funds are drawn only as needed, minimizing the interest costs over time.

Considerations Before Choosing

While reverse mortgages can be a powerful tool, they aren’t for everyone. It’s essential to:

  • Understand the terms and costs.

  • Assess the projected home value growth in your area.

  • Evaluate other financial resources and options.

  • Consult with a trusted financial advisor or mortgage agent to ensure the solution aligns with your long-term goals.

The Takeaway

Reverse mortgages are often misunderstood. Far from being a predatory product, they can provide a lifeline for homeowners seeking to fund care without selling their most valuable asset. As Scenario 2 shows, when used responsibly, reverse mortgages not only cover care costs but can also preserve a meaningful estate for heirs. By dispelling the myths and presenting the facts, we can better appreciate the role reverse mortgages play in providing financial stability and flexibility in retirement.

 

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