A new report from the Canada Mortgage and Housing Corporation (CMHC) finds more seniors are choosing to age in their homes longer before downsizing or renting.
Those who tap into the equity in those homes to meet day-to-day living expenses might not fully realize how the recent spike in borrowing costs will eat away at their nest-eggs much faster.
According to Statistics Canada, the number of seniors who borrow from their homes has held steady as interest rates spiked by nearly five per cent since March 2022.
That means home owners who draw cash through reverse mortgages and home equity lines of credit (HELOCs) are not only paying more for the amount they borrow, but the growing balances will compound at a faster pace, leaving less money to downsize, rent, or pass along to beneficiaries.
Posted five-year reverse mortgage rates from Home Equity Bank, the primary provider of reverse mortgages in Canada, can top ten per cent depending on the terms. Reverse mortgage rates are normally higher than convention mortgage rates, which currently range between seven per cent and eight per cent.
Interest rates on HELOCs, on the other hand, are currently in line with conventional mortgage rates.
HOW A REVERSE MORTGAGE WORKS
Reverse mortgages allow home owners aged 55 and older to borrow tax-free money against up to 55 per cent of the appraised value of their homes. Legal ownership remains with the homeowner but the amount borrowed and accumulated interest must be paid when the property is sold or transferred, or when the homeowner dies.
As 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.
HOW A HELOC WORKS
A home equity line of credit allows homeowners to borrow against the equity in their homes at will by simply transferring cash when they need it.
Borrowing limits can be up to 80 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.
LEVERAGED HOME OWNERS WILL SUFFER IN SILENCE
In both cases, equity in the home will be eroded at a faster pace if rates continue to rise and/or the value of the property falls.
The CMHC and other government and finance industry interests have expressed concern that household debt levels could pose a “systemic risk,” or risk to the entire financial system in the event of mass default.
But lenders actually benefit from higher rates and higher debt levels as long as borrowers have the ability to service it through regular payments.
In fact, whenever the economy tanks, HELOCs save far more people from credit defaults than they cause, which helps stabilize the financial system during crises.
That systemic risk goes away with home equity loans because the debt is secured by the collateral in the property and regular payments are not required.
As profits grow for lenders, seniors who borrow against their homes will be quietly squeezed as they sink deeper in debt, and could watch their home equity erode faster than it appreciates.
Under Canadian law, lenders can not confiscate a home, but as leveraged homeowners require more cash to meet living expenses, they could be forced to sell to cover their loan.