What a reverse mortgage really costs over ten years

The appeal of a reverse mortgage is easy to understand. The house is paid off, the pension covers the basics but not much more, and here is a way to turn part of the home's value into money without moving and without a monthly payment. For some households it is a reasonable tool. What the "no monthly payment" framing tends to hide is that the cost does not disappear; it accumulates quietly on the balance, year after year.

This article follows one illustrative loan for ten years, so the cost is visible in dollars. It does not recommend a reverse mortgage or any lender, and it names none.

How a reverse mortgage works

The Financial Consumer Agency of Canada (FCAC), a federal agency, describes a reverse mortgage as a loan for homeowners, usually aged 55 or older, secured against a home that is generally their main residence. The key points from its guidance:

• borrowers can usually take up to 55% of the current value of the home, depending on age, the home's type, condition and appraised value, and the lender;
• the money can be taken as a single lump sum, a lump sum followed by later withdrawals, or regular payments;
• no regular payments are required; instead, interest is added to the loan balance, so the amount owed grows over time;
• the balance must be repaid when the home is sold, when the borrower moves out, when the last borrower dies, or on default;
• interest rates are usually higher than for a standard mortgage or a home equity line of credit.

The FCAC also lists the other costs that can apply: appraisal fees, set-up fees, legal fees, closing costs, and penalties for repaying early. Some can be added to the loan, others are due up front.

Why compounding is the whole story

On an ordinary mortgage, interest is paid every month and the balance falls. On a reverse mortgage, unpaid interest joins the balance and then earns interest itself. That is compounding, and over a long period it dominates everything else. A rough rule of thumb: at an interest rate of about 7%, a balance that is never paid down roughly doubles in a little over ten years.

One loan, followed for ten years

Here is an illustrative borrower with a home worth $700,000 who takes a lump sum of $150,000, about 21% of the home's value. We assume $2,500 of set-up costs are added to the loan and an interest rate of 7.0% compounded once a year. Real products compound differently and rates change; the figures show the mechanism, not a quotation.

After ten years the borrower has received $150,000 and owes almost $300,000. The cost of borrowing, about $147,500, has been paid entirely out of the home's equity rather than out of the monthly budget. If house prices rise, that equity is partly replenished; if they stay flat, the remaining equity falls from $547,500 to about $400,000. Either way, the estate or the borrower's own future options carry the cost.

A comparison with paying the interest as you go

The alternatives worth pricing at the same time

The FCAC's own list of alternatives is a useful checklist. Each deserves its own arithmetic before signing anything:

• Selling and downsizing. Our article on what downsizing actually frees up counts every cost of the move.
• Renting, or moving to assisted living, where needs have changed.
• A home equity line of credit, a conventional mortgage or a personal loan, if the monthly payments are affordable.
• A property tax deferral program, where the pressure point is specifically the annual tax bill; see the deferral programs older homeowners can ask about.

Who this matters for, and what to check

A reverse mortgage is most often considered by homeowners in their late sixties and seventies with substantial equity and a pension that leaves little room each month. Before going further, it helps to ask for, in writing:

1. the interest rate, how often it compounds, and whether it is fixed or variable;
2. every fee at set-up, and which ones are added to the balance;
3. the prepayment penalty if the home is sold early, for instance to move into care;
4. a projection of the balance at five, ten and fifteen years;
5. what happens if a spouse who is not on the title is still living in the home.

The FCAC notes that some provinces and territories require independent legal advice before a reverse mortgage, and suggests getting it even where it is not required. A conversation with the family members who may one day settle the estate is worth having too.

What ten years teaches

A reverse mortgage does exactly what it says: it releases equity without monthly payments. The price is that interest compounds on the balance, and over a decade the amount owed can roughly double. Seen in a ten-year table, the decision becomes clearer. It is a question of whether the money now is worth the equity later, and that is a question only the household can answer.