Dale Jackson

Personal Finance Columnist, Payback Time

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It’s easy to see how the rising cost of living can hurt seniors living on fixed incomes, but there’s an added layer of inflation risk for seniors who need to borrow more from their homes to keep up with those added costs. 
 
Most of the attention has been on how the eventual rise in borrowing rates will impact new homebuyers and much less on how they will impact older homeowners who tap into the equity in their homes through reverse mortgages and home equity lines of credit (HELOCs). 

HOW REVERSE MORTGAGES WORK

Reverse mortgages allow homeowners aged 55 and up to borrow tax-free money against the equity they have built up in their homes, up to 55 per cent of the home’s value. Legal ownership remains with the homeowner and the amount borrowed, interest and outstanding fees are not due until the property is sold or transferred, or the homeowner dies.
 
Terms can vary according to the homeowner. Like the name implies, reverse mortgages are similar to conventional mortgages but instead of payments flowing into the home they flow out. That means instead of the principal (amount owing) falling over time, the principal rises over time. 
 
The combination of rising borrowing rates, and the need to borrow more to keep up with inflation will compound the total debt burden and eat away at the equity in the home; leaving less when the homeowner moves or passes away.

HOW HELOCS WORK

A home equity line of credit is a much less expensive option than a reverse mortgage but is still susceptible to rising interest rates. HELOCs allow homeowners to borrow at will by simply transferring cash when they need it.
 
There are normally upfront costs associated with setting up a HELOC. Legal and appraisal fees can be a few hundred dollars. In some cases, the bank will pick up the appraisal cost because it needs to know the true value of the property to be sure its loan is secured. Borrowing limits can be up to 85 per cent of the home’s appraised value minus any outstanding debt on the first mortgage. 
  
The interest rate on HELOCs is usually tied to the prime lending rate at most banks and the difference can be negotiated. If the rate is variable, however, the principal will be extra-sensitive to interest rate increases. In some cases a lender will offer fixed-term home equity loans over various periods of time like a conventional mortgage, but HELOC rates remain susceptible to rising interest rates whether the principal grows or not.
 
Rising home prices over the past few decades have allowed homeowners to reappraise their home values and increase the amount they can borrow against their homes for reverse mortgages and HELOCs, but there’s no guarantee home prices will continue to rise.
 
Central banks will raise rates as needed in the new year to cool the economy, which is being overheated in great part in Canada by the housing market.
 
If home prices stall, homeowners who need to expand their borrowing limits will come up against a brick wall because the equity in their homes will not be enough to cover the amount owed.
 
If home prices retreat, the outcome could be even worse for homeowners near their borrowing limits.
 
Under Canadian law, lenders can not confiscate a home but as homeowners require more cash to meet living expenses, and interest payments grow, they could be forced to sell to cover their loans or leave little to no equity for beneficiaries when they die.
 
Considering the popularity of home equity loans in Canada right now, it’s something worth thinking about.