One of the benefits of working with an independent mortgage professional is choice when it comes to mortgage product. When you work with a single bank or financial institution, you are limited to the products they offer. When you deal with a mortgage broker, you gain access to products from many lenders. Some of these products are very specialized and provide financing solutions as unique as the people they were developed for.
One such product is a reverse mortgage. In Canada, HomEquity Bank offers the CHIP reverse mortgage to homeowners 55+. It’s certainly not for everyone, but while mortgage products are becoming increasingly difficult to qualify for in Canada, it’s certainly worth considering if you meet the criteria. The following article was written by Roland Mackintosh, a business development manager at HomEquity.
The top 3 misconceptions about Reverse Mortgages are as follows:
1. The bank owns your home.
2. Your estate can owe more than your home
3. The best time to take a Reverse Mortgage is at the end of your retirement
Let’s examine each misconception in more detail.
The bank owns your home.
Over 50% of Canadian homeowners over the age of 65, believe the bank owns your home once you’ve taken a reverse mortgage. Not true! We simply register our position on the title of the home, exactly the same as any other mortgage instrument, with the main difference in the flexibility of not having to make P&I payments on the reverse mortgage.
Your estate can owe more than your home.
A reverse mortgage, unlike most traditional mortgages in Canada, is a non-recourse debt. Non-recourse means if a borrower defaults on the loan, the issuer can seize the home asset, but cannot seek any further compensation from the borrower – even if the collateral asset does not fully cover the full value of the loan. Therefore, when the last homeowner dies (and the reverse mortgage is due), the estate will never be responsible for paying back more than the fair market value of the home. The estate is fully protected – this is not the case for almost any other mortgage loan in Canada, which is full recourse debt. So read the fine print the next time you offer to co-sign for a loan for mom!
The best time to take a Reverse Mortgage is at the end of your retirement.
This is a common mistake that reflects an “old-school” financial planning mentality. For the majority of Canadians (without a nice government pension), the old school financial planning mentality is about cash-flow, and is as follows:
a) Begin drawing down non-taxable assets to supplement your retirement income.
b) Once your non-taxable assets are depleted, begin drawing down more of your registered assets (RSP/RIF) to supplement retirement income.
c) Once your registered assets are depleted, sell your home, downsize and re-invest to generate enough cash-flow to last you until you die.
The problem with the “old-school” financial planning model is two-fold:
2. You are missing out on a huge tax-saving opportunity by not taking out a reverse mortgage in the beginning of your retirement.
“Research has consistently shown that strategic uses of reverse mortgages can be used to improve a retiree’s financial situation, and that reverse mortgages generally provide more strategic benefits when used early in retirement as opposed to being used as a last resort.” – Jamie Hopkins, Forbes
In Canada, a reverse mortgage can be set-up to provide homeowners with a monthly draw out of the approved amount. For example: client is approved for $240,000 and decides to take $1,000/month. This is deposited into the clients’ bank account over the next 20-years. Interest accumulates only on the amount drawn (ie: not on the full dollar amount at the onset).
This strategy allows clients to draw down less income from their registered assets to support their retirement lifestyle. In turn, this can create some excellent tax savings, since home equity is non-taxable. Imagine lowering your nominal tax bracket by 5 – 10% each and every year over a 20 year period? The tax savings can be huge. You are also able to preserve your investable assets, which historically, can generate a higher rate of return when invested over a greater period of time.
A home is the largest purchase most people will make in their lives.
That should reinforce the importance of planning ahead, doing your research, relying on the advice of experts and not rushing through the process.
With nearly 700,000 homes purchased in Canada each year, there’s no shortage of anecdotes about the issues and surprises that can arise.
While a mortgage broker can help you avoid many of the pitfalls commonly encountered during the home buying process, it’s still important to be informed even before you start looking for that perfect home. Here are just a few examples:
1. Not checking your credit report before applying for a mortgage
Put simply, not knowing your credit score prior to applying for a mortgage is akin to not brushing your teeth before visiting the dentist.
Your credit score can have a huge impact on the best rate you’ll be able to secure. For example, some lenders will offer a borrower with a 640 credit score rates that are a full 0.25% worse than someone with a score of 750, as we’ve written about previously on these pages. For conventional mortgages (those with down payments of less than 20%), the ideal target score is around 720.
You don’t want to discover your credit score is sub-par in the middle of a mortgage application. Knowing this information beforehand gives you time to improve your score, or address any errors that may appear on your report. You can easily check your score through Equifax or TransUnion.
Anyone with a credit score less than 680 (the minimum credit score to get the best rates) should be prepared to pony up for a higher interest rate and will likely qualify for a smaller mortgage.
2. Thinking it’s all about the rate
Let’s be honest, who doesn’t want the cheapest mortgage rate possible? And indeed it is important to find the best deal that meets your needs. After all, a few percentage points can make a not-insignificant difference to your interest costs over your mortgage term.
But don’t be too quick to jump at the cheapest rate without making sure it has all of the features you need/want, and that it doesn’t stick you with higher-than-normal penalties should you need to break your mortgage early. Some people are OK with a large penalty if it saves them money upfront on the rate. Just remember that penalties on certain “no-frills” mortgages can end up costing many thousands of dollars, nullifying any rate savings.
3. Not understanding the importance of the down payment
Many first-time buyers see a down payment as a big, almost-insurmountable obstacle to home ownership, particularly in regions where prices have skyrocketed into the stratosphere.
But when you get into the nitty-gritty of it all, there are many more considerations beyond simply coming up with the money.
Things to consider:
How big of a down payment will you/can you make? Of course you must meet the federally mandated minimum down payment: 5% for all mortgages up to $500,000, and 10% on any portion above $500,000 up to $1 million (CMHC-insured mortgage loans are only available on properties valued under $1 million). It goes without saying that as you increase the size of the down payment, you reduce the amount of interest over the lifetime of the mortgage. But you also reduce the size of the CMHC mortgage insurance premium, which runs from 0.60% on loan-to-values up to 65%, all the way up to 4% for loan-to-values of 95% (i.e. 5% down). CMHC says the average down payment in 2016 was 8%, while the average CMHC-insured loan was $245,000. Based on those figures, the average premium was $9,016. Remember, this premium is normally rolled into the mortgage, and gets paid off (with interest) over the life of the mortgage.
The source of your down payment funds. According to Mortgage Professionals Canada, about 10% of first-time buyers use the federal government’s Home Buyer’s Plan to withdraw up to $25,000 tax free from their Registered Retirement Savings Plan (RRSP). This can be a great tool for supplementing a down payment, so long as you’re aware of the rules and the payback requirements.
Transferring the funds. No matter where your down payment funds are coming from (savings, investments, RRSP, proceeds from a prior sale), be sure to leave yourself plenty of time for the funds to clear and for a certified or cashier’s cheque to be produced before the closing. It’s easy to underestimate the time it may take for wire transfers to finalize, so be sure to confirm with your bank or financial institution in the event of a tight deadline.
4. Not setting (and sticking to) a budget
You’re probably thinking, “but budgets can be boring and tedious.” This is not entirely incorrect, but on the other hand a budget paints a clear picture of your financial situation and lays the framework for ensuring you can afford all of the hidden (and not so hidden) costs associated with buying a home—not to mention all of the costs that follow after the closing.
It’s important to plan for both the short and long term. Short-term costs include everything from:
Land transfer taxes
Home inspection/appraisal fees
Down payment (this is kind of a big one)
Mortgage insurance (remember, the provincial tax on your insurance premium can’t be rolled into the mortgage like the premium itself, so expect this hefty expense at closing time)
Then there are the ongoing costs of home ownership. Previous owners will know what to expect, but first-time buyers may be caught off guard with sudden expenses after moving in, such as:
Appliances and furniture
Condo fees/Property taxes/Property insurance
Renovations/repairs (furnace replacement, new shingles, etc.)
And everything else, down to tools, and yes, even a dehumidifier. These expenses can add up
As for long-term planning—and this applies especially to today’s buyers—just because you scored a great rate for your purchase, be prepared for the possibility that rates will rise and that you may need to renew into a higher rate in the future.
For every 25 bps or rate increases, adjustable-rate holders can expect to pay approximately $25 more in interest each month based on a $200,000 mortgage.
5. Not Shopping Around
Whether you plan to find your own mortgage or enlist the help of a broker, it’s still important to shop around in both cases.
Most people don’t buy the first car they test drive. They give themselves adequate time to research and compare their options. So why would a purchase worth many times the cost of your vehicle be any different?
So you’re thinking about co-signing for a mortgage? Okay, do you really know what that means do you know what you are getting yourself into? Co-signing isn’t necessarily a bad thing, but there is certainly a lot of misinformation floating around on the subject. Although its nice to be in a position to help someone close to you qualify for a mortgage, It’s not a decision that should be made lightly. Co-signing on a mortgage could have a significant impact on your future.
Here are some things you should consider before co-signing a mortgage application.
1. Regardless if you’re the principal borrower, co-borrower, or co-signor, If you’re on the mortgage, you’re 100% responsible for the debt of the mortgage and everything that goes along with that. Although the term co-signor makes it sound like you are somehow removed from the actual mortgage, you have all the same legal obligations as everyone else on the mortgage.
2. If the person who you’re co-signing for is unable to make the payments for any reason, you will be expected to make them on their behalf. By signing the mortgage documents, you assume full responsibility for the payments (even if it’s not you making them).
3. If payments aren’t being made, there is a chance the lender will take legal action against you. This includes all available collection methods such as obtaining a judgement in court or garnisheeing your wage or bank accounts. Worse case scenario, they could actually go after your property or assets in order to cover their loses. Now, this is highly unlikely, but not out of the realm of possibility.
4. Once the initial term has been completed, you will not automatically be removed from the mortgage. The person who you co-signed for will have to make a new application for the mortgage in their own name and qualify on their own merit. If they don’t qualify at this time, you will be kept on the mortgage for the next term.
5. When you co-sign for a mortgage, all of the debt of the co-signed mortgage is counted against you. This means that if you’re looking to buy another property in the future, you will have to include the payments of the co-signed mortgage in your debt service ratios, even though you aren’t the one making the payments. This could significantly impact the amount you can borrow in the future.
Here is the latest economic update from Verico’s economist Michael Campbell.
I think that anyone working in the real estate industry can be forgiven for waking up in a cold sweat muttering what Ronald Regan called the 9 scariest words in the English language: “I’m from the government and I’m here to help.”
All three levels of government have set their sights on cooling both the Vancouver and Toronto real estate markets along with Victoria, Hamilton and Saskatoon but to whose benefit? What’s rarely mentioned is that not a single homeowner in any city benefits from lower prices and reduced liquidity.
Read more from VERICO’s Economist Michael Campbell by clicking the report below.
Recently, the Bank of Canada released its semi-annual Financial Systems Review (PDF document), which identifies some of the major risks that the Bank foresees on the economic horizon.
Unsurprisingly, the Bank pinpoints increased levels of Canadian household debt and rapidly increasing prices in Toronto and Vancouver as vulnerabilities to the financial system. The good news is that, despite these vulnerabilities increasing over the past six months, the Bank of Canada is confident that the financial system remains resilient, and that overall, national economic conditions continue to improve. This positive outlook, combined with strong economic growth, are playing a role in the not-so-subtle hint that the Bank may increase interest rates sooner rather than later.
So what does this policy review indicate for future federal interventions in the mortgage market? The short answer is a lot.
It is no coincidence that the aforementioned vulnerabilities mirror the rationale used by the federal government for the mortgage insurance and eligibility changes in October. The Bank of Canada, the Department of Finance and CMHC are all aligned and focused on curbing elevated levels of household debt and ensuring the stability of the housing sector. This report could be viewed as representative of the problems and policies that the finance department is considering.
It is no surprise then that the Bank of Canada is pleased with the impact that the October changes have had on the debt-to-income ratios of insured mortgages (chart 3). But, the changes have also had an impact on increasing the market share of new mortgages that are uninsured. Clearly, this was an intended impact of the federal government’s changes and now the Bank of Canada is identifying the uninsured space as the next place to consider in terms of whether action is needed.
The Bank’s concerns will likely find a supportive audience at the Ministry of Finance and at CMHC. The data showing the increasing debt-to-income ratios for the uninsured sector (table 1) could trigger an investigation into additional regulation in the uninsured space by the Ministry of Finance or OSFI.
The first measure that is likely being considered is related to Home Equity Lines of Credit (HELOCs). This is clear for two reasons. First, because the Bank of Canada believes that the greater use of HELOCs could also be contributing to increasing household indebtedness. According to the Bank, HELOCs have increased at rates above income growth since early 2016, and have accounted for approximately 10 per cent of total outstanding household credit in recent quarters. Second, the Financial Consumer Agency of Canada recently released a report raising concerns that HELOCs may be putting some Canadians at risk of over borrowing. The timing of this report and the Financial Systems Review may not be coincidental.
It seems OSFI may be considering making changes to its B-20 underwriting guidelines; the Bank of Canada’s report suggests that OSFI will begin a public consultation shortly.
The critical policy question that the Department of Finance could be considering is whether to extend the stress test for insured mortgages to uninsured mortgages as well. This could create a more even playing field for lenders who originate a greater percentage of insured mortgages and could possibly have an impact in cooling the markets of Toronto and Vancouver. However, it could also negatively impact the rest of the Canadian housing market, which is not suffering from the same vulnerabilities of Toronto and Vancouver and could become unnecessary if the Bank of Canada raises interest rates.
Finally, there was a small policy section in the review that few may have paid much attention to but is important and provides some very helpful insights into the future of Canada’s private mortgage securitization market. The Bank of Canada recognizes that the recent changes have negatively impacted mortgage lenders that rely on portfolio insurance and that the increased growth in uninsured mortgages have created an opportunity for private residential mortgage-backed securities. The Bank of Canada goes even further and suggests that “properly structured private securitization would benefit the financial system by helping lenders fund loans.” (page 13).
It is surprising that this issue hasn’t received more attention because the Bank of Canada is tacitly endorsing a significant policy shift away from CMHC-backed mortgage securities to a private sector mortgage securitization market. This confirms that the creation of this market is an intended impact from the federal government’s changes to portfolio insurance and aligns with CMHC President Evan Siddall’s testimony to the finance committee on the changes to portfolio insurance.
Until the Bank of Canada is convinced that the housing sector no longer poses the greatest liability to the Canadian economy, Canadians will continue to see the federal government scrutinize mortgage activity in Canada with an eye to reduce the increasing levels of household debt in the country..
Let’s hope the government shifts their focus to unsecured household debt instead of further secured debt restrictions. However, if the Bank of Canada’s review is representative of the Ministry of Finance’s considerations, watch out for changes to HELOCs, through B-20 changes, the stress test being applied to uninsured mortgages and continued growth in the developing private sector mortgage securitization market.
This article originally appeared on Canadian Mortgage Trends, a publication of Mortgage Professionals Canada on June 20th 2017. It was written by the manager of government and policy for Mortgage Professionals Canada, Samuel Duncan.