After years of unprecedented growth in the Canadian real estate market, many homeowners have amassed considerable wealth in their homes.
For example, some homes in Ontario and BC bought ten years ago for $200,000 are now worth as much as $700,000, equating to a $500,000 net gain in equity.
Rather than selling their property, some homeowners are borrowing against their homes or refinancing, allowing them to retain ownership while benefitting from the rise in equity. Homeowners can do so with a cash-out refinance, a home equity line of credit (HELOC), a home equity loan, and sometimes a reverse mortgage.
Why would you get a reverse mortgage?
In all transparency, a reverse mortgage is rarely a homeowner’s first choice. Compared to a HELOC or cash-out refinance, reverse mortgages have comparatively higher fees, worse early payment penalties, and stricter terms. Yet, it may be your only option if you have poor credit, no income, or little to no savings.
Reverse mortgages do come with some favourable terms. The most significant advantage of reverse mortgages over other home equity products is that borrowers don’t have to make any minimum payments on the loan. Borrowers only have to pay the balance once they leave the home — which could take decades — or if they’ve violated any of the terms outlined in the loan agreement, such as leaving the home for more than six months or failing to pay property taxes.
Until recently, a reverse mortgage was the only option homeowners had for a payment-free mortgage. Thankfully, modern lenders like Fraction are disrupting the space with their own payment-free mortgages with lower rates and more flexible terms, giving Canadians more choice and control over their home equity.
For an in-depth comparison, check out Fraction Mortgage vs. reverse mortgage.
Essential facts about reverse mortgages
Reverse mortgages are unique compared to other home equity products, so it’s essential to know the nuances of the offering.
- Reverse mortgages allow Canadian homeowners to access their home equity in cash without selling or downsizing their homes. For those with significant equity but otherwise minimal savings or income, a reverse mortgage can be an effective way to ease retirement with funds to supplement retirement income, pay down debt, or cover high medical fees.
- Reverse mortgages are non-recourse loans, meaning that the borrower will never owe more than the fair value of the home. If the mortgage balance exceeds the home's value by the end of the term, the borrower won’t be on the hook for the balance in excess of the home value. Moreover, the lender cannot force the borrower to leave or sell the home even if the arrangement is no longer profitable for the reverse mortgage lender.
- Borrowers must be 55 or older to qualify for a reverse mortgage in Canada. This policy applies to co-owners of the home as well. If a co-owner is below the age of qualification, they will be left off the reverse mortgage agreement and not protected by the terms of a non-recourse loan.
- Borrowers must remain in the home for at least six months out of the year. Once the borrower leaves for more than six months, the property will cease to be their primary residence, and the reverse mortgage lender has it in their rights to call the loan. Borrowers who want to use the funds to pay for assisted living or a retirement home for themselves may want to consider other avenues.
- Borrowers retain ownership of the home. However, the lender may have it in their rights to force a home sale if the borrower fails to uphold the terms of the reverse mortgage agreement.
What happens when you inherit a home with a reverse mortgage?
Depending on how much equity remains in the property once the loan has matured, heirs will have a few options for moving forward.
Option 1: Sell the property
To settle the balance due on the reverse mortgage, heirs can choose to sell the property. Any equity remaining after paying off the balance can then be dispersed to the heirs. If the home value falls below the amount due, you will be required to give all sale proceeds to the lender, while the remaining balance difference will be forgiven or covered by the lender. Keep in mind that you may incur some costs if you choose this route, such as paying for an appraisal to assess the home's fair market value.
Option 2: Repay the lender
If you would like to retain ownership of the property, you may choose to repay the lender for the balance owed. You can do so with cash, a loan, or a traditional mortgage. Although the reverse mortgage may have accrued significant interest, this may be a worthwhile avenue if the property has sentimental value or unrealized investment potential.
Option 3: Turn over the keys
If you are confident that selling the home would just cover or fall below the owed balance on the reverse mortgage, you can choose to sign a foreclosure deed and transfer ownership to the lender. This route will require the least effort on the heirs' part, but you should be sure that you aren’t leaving any equity on the table before pursuing this option.
Do you pay taxes on an inherited home with a reverse mortgage?
Although Canada does not have an inheritance or death tax, there may be applicable taxes if you choose to sell the home, in addition to probate fees which will apply once the estate enters probate for evaluation.
Capital gains tax
According to the Canadian Revenue Agency, 50% of the profit (or capital gains) realized from selling a property are taxable at applicable rates. That means if you sell the inherited property to settle the reverse mortgage balance, 50% of the remaining equity (if any remains) will be taxed. If you choose to settle the reverse mortgage balance via other means, whether via cash payment or refinance, you will not pay a capital gains tax. However, if you choose to sell the property at a later date and do make a profit, 50% of your capital gains will be taxed.
Probate is the formal process of the courts accepting a will or appointing a person to act on the deceased’s behalf in the absence of a will. During probate, the executor or administrator will verify that the testator has passed away, and that the will is indeed valid. There are fees associated with this process that vary by province.
In the case of inheriting a property with a reverse mortgage, fees will only apply to the difference between the home value and the balance on the mortgage. All debts are subtracted from the estate value, so you don’t have to worry about incurring fees on the entire value of the property.
Settling the balance
As the heir to a reverse mortgage, your job is to determine how to settle the balance due by selling the property, paying off the balance and retaining the home, or handing over the keys to the lender.
Most reverse mortgage providers will allow you up to 12 months to repay the balance, but terms vary from lender to lender. It’s essential to speak with your lender to determine the best course of action forward.