Perhaps I’m foolish, but I’ve never really worried about retirement savings. In fact, I’ve always thought that my home would make for a good retirement plan - and I'm not alone in that idea. There are actually two good ways to make use of the equity in your home, although each comes with its own set of risks. As a retiring homeowner, you can tap into your home’s equity through a reverse mortgage or a home equity line of credit (HELOC).
Let’s start with the reverse mortgage. A reverse mortgage is when your home’s payment in reversed. Instead of you making a monthly payment to your lender, your lender makes a monthly payment to you. If you continue to live in your home, it can be arranged that these payments go on for the rest of your life. Sound too good to be true? Well, there are some restrictions. Reverse mortgages come with age limits (you can only reverse your mortgage after 62), and there’s a maximum amount of money that can be accessed. It also comes with a higher rate of interest, according to an article in the Financial Post. While interest rates for regular mortgages were sitting at 2.99% this summer, the rate for a Canadian Home Income Plan reverse mortgage was 5.5%.
Those who are not interested in paying the fees associated with a reverse mortgage often turn to a home equity line of credit. This allows the homeowner access to some of the appraised value of their home, but the borrower must make payments on the interest. The full amount is due when the homeowner either sells their home, or dies. This summer, as Canadian Finance Minister Jim Flaherty was trying to get Canadians to lower their debt to income ratio, the Office of the Superintendent of Financial Institutions (OSFI) warned against these products. In fact, they asked banks to consider reducing the loan-to-value ration from 80% to 65%.
“HELOCS are inherently riskier products, given their revolving nature, persistence of debt balances and their ineligibility for mortgage insurance,” warned OSFI.
The other problem with home equity savings is that too many homeowners tap into them too early. They use them to pay for vacations, to buy new cars and to consolidate outstanding debt. Homeowners who do this are essentially nibbling away at what could be their only opportunity to finance their retirement. If done correctly and carefully, however, a home equity line of credit can be used to not only get rid of burdensome debt, but also to fund retirement in our later years.
One defining feature of HELOCs is the variable nature of their interest rates - so homeowners currently looking to take one out can't access historically low fixed rates. As history proves, variable rates will go back up - and those borrowers may be challenged to repay their loans at higher costs.
Other experts suggest using the equity in your home to fund your investment portfolio – another option with obvious risks. You should only use this as an option if you could still make ends meet if the investment fails though. While taking out loans against your home to fund investments was once popular, given the more volatile state of the market, it is currently a less popular option.
At the end of the day, the choice is yours. Only you know what will work best for you. Always talk to a financial advisor or a qualified individual before making major financial decisions of this kind. And happy retirement!