Tuesday, August 03, 1999
Home is more than retirement shelter:John Archer
Financial Post
Your home may be your castle, but as you enter your retirement years it may also be a potential source of retirement income. In fact, the family home typically represents as much as 80% of the average retired Canadian's assets. That can mean substantial capital being tied up in real estate which, in many parts of the country, is a low-performing asset.
There are many ways use this asset to help fund your retirement income. The most common strategies are as follows:
Downsize: Certainly an argument could have been made to have a large home when your children were growing up, but now that they've left, do you really need so much space? If not, consider selling and buying another home or a condominium that is smaller.
Presumably, the cost of a new home will be less than the proceeds of your old home, and the surplus money could be rolled into an investment account to supplement your income. There are no tax consequences for selling your principal residence, which can be a further incentive to mobilizing that capital. Depending on how you invest the surplus, there may, of course, be tax consequences on a new stream of retirement income.
Sell your home and rent instead: Your present home's resale value may not be growing as fast as you may think. In fact, most financial planners use a potential annual growth rate of 2% to 3% when calculating your potential return on this type of "lifestyle asset."
If you were to use that capital to invest in a balanced portfolio of bonds, stocks and/or mutual funds, it would be reasonable to project an annual return of 7% to 9% in the long term. More aggressive portfolios may produce greater returns.
When selling a home, many people wonder if renting really will be cheaper than buying a new home. In many cases, the answer will be "yes." You can do the math on the Internet. I suggest using www.canadamortgage.com. Go to this site's "Calculate" section and click on "Rent v. Own". Input a few figures -- taxes, insurance costs, and mortgage payments versus rental costs -- and you'll have cyber proof of the best route to take. If you don't have access to the Internet, call your grandson or head to your local library.
Consider a reverse mortgage: This is as close to "having your cake and eating it, too" as one can get. Providing you are over age 62, a reverse mortgage gives you access to a substantial portion of your home's current value -- without having to sell your home. Simply put, the scheme allows you to borrow against the value of your home without having to repay the debt until you die (at which point your estate settles the loan using the proceeds of the property's sale or other assets) or if you were to sell the home.
Reverse mortgages have allowed many Canadians to keep their homes during retirement because the arrangement has provided them with the necessary income or capital liquidity to weather unexpected cash-flow problems.
An major provider of reverse mortgages is the Canadian Home Income Plan, or CHIP. Its reverse-mortgage plans are available in British Columbia, Alberta, Manitoba, Ontario and Quebec. Homes in most cities in these provinces would qualify for reverse mortgages -- but not all.
Depending on the location of your home and your age (you must be 62 or over; if married, so must your spouse), CHIP will lend you between 10% and 40% of your home's appraised value.
Once the reverse mortgage is approved, the money will be distributed to you as a lump sum -- which you can invest to provide yourself with income or use it to buy an annuity -- or as a stream of regular income (similar to an annuity). Or you can opt for a combination of these two methods.
Upon your death (or the death of your spouse, whichever occurs later) or the sale of your home, the amount loaned to you (plus interest) must be repaid to CHIP. Currently, CHIP's annual interest rate is 8.9%.
One of the problems of the reverse mortgage is that it may severely deplete the value of your estate -- although, depending on your situation, that might not be a concern. However, CHIP strongly recommends you review the reverse mortgage option with your family and financial advisors before proceeding. A reverse mortgage represents a debt, and if you have just finished paying off your mortgage, the idea of revisiting debt might not appeal to you.
Keep in mind the income received from the reverse mortgage is basically tax free; the deductibility of the interest charged offsets the tax on the income. What's more, the income does not affect the government's clawback of Old Age Security.
The reverse mortgage used to have the stigma of "lender of last resort," but homeowners' gradual acceptance of the scheme and the relatively few problems or abuses have earned it respectability among financial planners.
Refinance your home: This is a more aggressive strategy because it involves leveraging the equity in your home for investment purposes. Under this scenario, you usually take out a mortgage, or borrow against the equity in your home in the form of a home equity line of credit. You then take this borrowed capital and invest it under the assumption that gains in your investment portfolio will surpass the interest charges on your mortgage.
The refinancing strategy is most often the subject of abuse because investments can go sour and some seniors find themselves paying high mortgage payments (for a mortgage that was once paid off) to finance investments that may be declining in value instead of rising.
Moreover, mortgage payments can put a strain on your retirement cash flow. Portfolios funded this way tend to be growth-orientated rather than focused on generating income. That results in more investment volatility than many retirees would like to experience.
One advantage of a reverse mortgage instead of refinancing is that the former usually are repaid only at death or when the home is sold, and no regular repayments are required while you own it. This is more in line with your original intent: liberating your home's capital to provide retirement income, not just for investment.
The bottom line is your home may be the nest egg of retirement income that you always hoped it would be, but there is more than one way to hatch that potential.