By Michelle Bates
Michelle Bates is an editor and writer in the personal finance space, where she reports on topics such as mortgages, insurance, and credit cards.
Like a conventional mortgage, a reverse mortgage is a loan secured by the value of the home, but with no monthly mortgage payments required. It provides Canadian homeowners age 55+ access to tax-free cash of up to 55% of the appraised value of their home. Reverse mortgages have grown in popularity as we’ve seen an increase in the cost of living and real estate prices over the last two decades. More and more Canadians are looking to access home capital to help supplement their retirement income, without having to sell the home they worked so hard to buy.
Reverse mortgage rates can be higher than those of a conventional mortgage due to the fact that regular payments aren’t required, which is a great benefit to those with limited or a fixed income in retirement. Despite the higher rates, reverse mortgages can be a strategic and savvy approach to financing retirement as the homeowner retains ownership of the property, enjoys its appreciation, and can avoid costly, disruptive and unwanted downsizing.
Similar to conventional mortgage rates, reverse mortgages are offered with fixed or variable rate terms and are impacted by the actions of the Bank of Canada (BoC). Since the BoC raised its overnight interest rate for the third time this year, to 1.50%, on June 1, mortgage rates are no doubt on the minds of many homeowners. This is also true for Canadians with a reverse mortgage or those considering one.
Considerations for reverse mortgage rates
Reverse mortgage providers have a variety of product features and solutions to suit specific needs, including the option for variable or fixed interest rate terms. The variable versus fixed rate discussion is an ongoing debate and really boils down to the borrower’s appetite for risk.
There are a few fundamental differences between fixed and variable rate mortgage options that should be understood. Fixed-rate mortgages lock in a specific rate, providing cost stability for the duration of the term. Variable rates, on the other hand, rise and fall based on the state of the economy and corresponding actions by the BoC.
Mortgage rates are heavily impacted by the BoC’s rate decisions to manage inflation and promote a healthy economy. Very simply, if inflation is rising the BoC must raise rates to decrease consumer demand by attracting money into more lucrative savings instruments and away from consumer spending. The opposite is true when the economy stalls; the BoC lowers rates to encourage spending by making savings options less attractive.
The main consideration when choosing between a variable and fixed rate for a reverse mortgage is your comfort with risk and ability to absorb increased costs if rates rise. But because reverse mortgages don’t require payments, the concept of affording higher rates has to do with the impact of rising rates on the overall amount of the reverse mortgage loan rather than the cashflow required to meet monthly payments.
Reverse mortgage rates: choosing fixed versus variable
Choosing a fixed versus variable rate structure comes down to your risk appetite and comfort with volatility.
At the time of this article being published, a variable CHIP Reverse mortgage offered by HomeEquity Bank has a lower variable interest rate compared to a fixed interest rate. However, if the BoC continues to increase the overnight interest rate, variable rates could soon be higher than fixed rates.
So, while a fixed rate might not be the more affordable option right now, it does guarantee you the same rate for the term of your mortgage. However, at the time your term is up, it is very likely that rates will be either higher or lower than your original term. At this point, you must revisit your decision-making process and reevaluate your appetite for risk and rate volatility.
While variable-rate reverse mortgages are more volatile, they do offer the reward of potentially lower overall borrowing costs. However, there is the possibility that the costs of a variable rate mortgage may match or exceed the fixed-rate option for a specific period of time.
When does switching reverse mortgage rates make sense?
Deciding to switch to a new rate structure for your reverse mortgage is a major decision with both costs and benefits to consider. Generally speaking, if you’re switching from a variable-rate reverse mortgage to a fixed-rate reverse mortgage, minimal penalties will be incurred, and the process is relatively easy. Borrowers who hold a variable-rate reverse mortgage may consider this option when the economic forecasts predict ongoing inflation, economic volatility, and correspondingly higher rates.
If you decide to switch from a fixed-rate reverse mortgage to a variable-rate reverse mortgage the process is more complicated and costly. Depending on the duration remaining on your reverse mortgage term, there may be fees associated with switching. To break a fixed-rate mortgage midway through your term, you’ll typically pay either three months’ interest on your outstanding loan or what’s called an interest rate differential (IRD), whichever is higher. The IRD is the difference between the remaining interest left on your original fixed rate loan and the amount of interest you will be charged on the new variable rate loan.
Essentially, the bank ensures you cover your original interest obligation but unlocks the rate going forward and allows it to move with the market. Reverse mortgage holders with not a lot of time left in their term may consider this if they locked in at a relatively high rate compared to current rates if they are projected to drop or remain static over the duration of their current term. The switch from fixed to variable is more costly, more complicated, and less common.
When the mortgage term is up, you have the freedom to move from a fixed rate to variable rate. Although there will be no penalties, you need to consider the current economic situation as well as the near future economic outlook. If the economy is stagnant or slow and this pattern is to hold, then it may make sense to switch to a variable rate.
If you’re a Canadian homeowner 55+ who’s considering a reverse mortgage, you have the freedom to choose either a fixed rate or a variable rate. The most important thing is to understand your tolerance for risk and assess the economic situation before deciding on the interest rate best suited for you.