What is a reverse mortgage and how does it affect home equity?
A home equity reverse mortgage is a loan secured against your home and is available to Canadian homeowners aged 55-plus. For a reverse mortgage, home equity is an essential component, because the amount of equity will determine the size of the reverse mortgage home equity loan available to you.
A reverse mortgage home equity loan allows you to cash in up to 55% of your home’s value but included in that 55% will be any loans you already have against your home, which will be paid off by the reverse mortgage.
Any loans taken out against your home (including a traditional mortgage, home equity line of credit and a reverse mortgage home equity loan) will affect the amount of equity that remains. Your equity will be reduced by the amount of the loan, though your equity will change over time, and we will go into that in more detail in this article.
What does home equity mean?
Some people think of home equity as being a means to secure loans, particularly those that help make improvements to their home, but there is much more to it than that. So, what is home equity, exactly, and how is it calculated?
Home equity is the amount of your home’s value that you own outright. You can calculate it by taking the appraised value of your home and then deducting all loans that are outstanding against it. These loans can include a mortgage, home equity loan and home equity line of credit.
Let’s say your home has just been appraised at a value of $800,000. You have a mortgage of $220,000, a home equity line of credit of $19,000 and a home equity loan of $26,000. Here is how you calculate your home equity:
$800,000 – ($220,000 + $19,000 + $26,000) = $535,000 home equity
How your home equity can grow
Typically, your home equity grows year after year (unless the housing market were to plateau or experience a considerable crash). There are several ways your home equity can increase:
• You pay down what you owe against your home
• You make extra payments on your mortgage
• Home values increase
• You have renovations done that increase the value of your home
How does a reverse mortgage affect your home equity?
Firstly, homeowners need to have sufficient value in their home to qualify for a home equity reverse mortgage. How much equity for a reverse mortgage do you normally need? A home equity CHIP Reverse Mortgage, for example, has a lending limit of 55% of your home’s value.
There are several advantages and disadvantages of reverse mortgages, and one of the key reverse mortgage benefits can have an impact on your home equity. Home equity reverse mortgage customers don’t have to make any mortgage payments, and this means that the amount they owe increases every year (because of the annual interest charged). They can make interest and lump-sum payments if they wish to.
However, the whole value of your home typically rises every year, whereas it is only the amount of your loan that increases with compound interest on the initial amount borrowed plus the fees and charges.
This short video explains the process even further. It shows how a CHIP Reverse Mortgage could impact your home equity value over time and on average CHIP customers have over 50% of the value of their home to enjoy after repaying the loan. https://www.youtube.com/embed/9Y_zo3q5T2U
How a reverse mortgage can affect your home equity in numbers
Let’s say you decide to take out a home equity reverse mortgage today, for $200,000, and your house is worth $500,000. Your home equity would be worth $300,000 today.
You take advantage of the reverse mortgage benefits and make no regular mortgage payments. Your interest rate is 4.65% (this is HomeEquity Bank’s current three-year fixed mortgage rate in July 2021 subject to change – you can see our up-to-date rates here).
After a year, you will owe $209,300 on your equity home mortgage. If home values increase by 3% this year, your home would be worth $515,000 in a year’s time (over the last 15 years, home values in Canada increased by an average of 6.4% per year).
After a year, your home equity would be:
$515,000 – $209,300 = $305,700*
Your home equity would have increased by $5,700, even if you made no mortgage or interest payments.
Here are some more examples, using the same constants of a 4.65% reverse mortgage interest rate and an estimated increase in home value of 3% over the coming year.
Home value Reverse mortgage amount Current home equity Home equity after one year
| Home value | Reverse mortgage amount | Current home equity | Home equity after one year |
|---|---|---|---|
| $300,000 | $100,000 | $200,000 | $204,350 |
| $500,000 | $100,000 | $400,000 | $410,350 |
| $700,000 | $200,000 | $500,000 | $511,700 |
| $800,000 | $250,000 | $550,000 | $562,375 |
| $1,000,000 | $350,000 | $650,000 | $633,725 |
Of course, if home prices were to fall or plateau, the amount of equity in your home would decrease, but this would also be the case even if you didn’t have an equity-based home mortgage.
How you could miss out on growing equity if you downsize
Meet Ralph and Gina. Rather than take out a reverse mortgage, they decided to sell their $500,000 house in Ontario and moved into a $300,000 condo. After paying realtor fees, land transfer tax on their new home, removal costs and legal fees, they were left with just over $160,000. They now had the added cost of condo fees and ended up spending their money after seven years.
Over that period, home values increased at an average of 6% per year, and their old home’s value had increased by over $250,000. Had they stayed in their old home and taken out a reverse mortgage, they wouldn’t have had to pay annual condo fees or almost $40,000 in total moving costs, and they would be eligible to cash in some of the new equity in their home.
Why should you opt for a home equity CHIP Reverse Mortgage?
Like all types of loans, there are advantages and disadvantages of reverse mortgages. Some of the key reverse mortgage benefits that make it a popular choice among Canadians aged 55-plus are:
• You can cash in up to 55% of your home’s value
• You can choose to receive the money in a tax-free lump sum or in regular tax-free payments
• It can prevent you from having to downsize
• You don’t need to make regular mortgage payments
• You only pay back what you owe when you sell your home or move out
• You can use the money for absolutely anything
• It provides the money to ensure you have the retirement you always wanted
And as we’ve seen, another of the reverse mortgage benefits is that, even if you don’t pay any interest on your equity home mortgage, your home equity can still continue to increase.
When it comes to considering the advantages and disadvantages of reverse mortgages, it’s important to remember that reverse equity home mortgages in Canada are very different from those in the US and other countries.
HomeEquity Bank is a Schedule 1 bank and therefore regulated by the Canadian federal government. You always maintain ownership and control of your home, and we promise that you’ll never owe more than its fair market value. You get access to additional funds without having to move, sell or downsize, which can have a big emotional and financial impact.
Also, when looking at the advantages and disadvantages of reverse mortgages, there are some other important aspects to consider. For example, equity home mortgage rates can be higher than conventional mortgages because this is a premium product that does not lend solely based on credit score and income like the major banks, and your loan balance will increase over time (unless you choose to make interest payments).
The biggest benefit of taking a CHIP Reverse Mortgage is that you can cash in some of your home equity without having to move or sell.
Find out more about reverse mortgage benefits and how much equity from a reverse mortgage you could qualify for. Contact a home equity CHIP Reverse Mortgage specialist today at 1-866-522-2447 or use our reverse mortgage calculator to work out how much you could borrow.
* Home equity calculations are made using simple interest, rather than compound, and are for illustration purposes only. Actual amounts may vary.
