Reverse Mortgage Penalties Explained

Penalties – for paying back the reverse mortgage balance – are one aspect of a reverse mortgage that work very differently to a regular mortgage.

Even if you don’t intend to pay it back (you plan on living in your home forever), you should review this information just for informational & educational purposes – just in case.

I’ll walk you through penalties and explain how they compare to regular mortgages – then finish by giving you some real-life examples.

You can watch the video version or read the article in full, both are below.

Overview Of Mortgage Penalties

All mortgages in Canada have penalties when you are paying the balance owed early.

With reverse mortgages, the rules on penalties are very different to regular mortgages.

I’ll briefly explain how regular mortgage penalties work, then show you how they work with reverse mortgages before giving you some examples, so you can clearly understand the difference.

But First: When Do You Not Need To Worry About Penalties At All?

Penalties only apply if (and when) you’re paying off the reverse mortgage balance.

If you’re planning on staying in your home forever (which is one of the purposes of a reverse mortgage) then you will have no penalties on a reverse mortgage – there are no penalties where all the owners pass away.

Also, there are no penalties if paying off a reverse mortgage after 10 years with any of the present lenders.

Regular Mortgages

A regular mortgage generally has an amortization period of 25 years. Amortization is a fancy accounting word for ‘pay pack period’ – the amount of time to pay the loan back.

This is then broken down into ‘terms’. This indicates how long the rate you get applies for – for example, the most common term in Canada is a 5 year fixed rate term.

If you chose a 5 year term, at the end of the 5 years, you’ll renew into a new term. If you had 5 x 5 year terms, you’d have paid the entire 25 year mortgage loan.

Here are 2 different ways (of the many) you can pay off a regular mortgage using various terms:

As you can see, you could take out 5 x 5 year terms and then pay off your mortgage – that’s option 1.

Or you can move around between various different terms along the way – that’s option 2. There are endless possibilities of all the different terms you can have along the way to paying off your mortgage (over 25 years).

You can choose fixed rate or variable rates for most of the terms too (variable tends to only be available on 5 year terms and occasionally on 3 year terms).

Regular Mortgages – Penalties

With a regular mortgage, at the end of each term (1-5 year), you can pay the mortgage off without penalty.

The penalty you pay will be directly influenced by the amount of time remaining in your term and the type of rate you have (variable vs fixed).

For example:

• If you pay the mortgage off 2 years into a 5 year fixed rate term, you’ll likely pay a penalty based on the remaining 3 years. There’s a complicated formula for this called the IRD that I won’t get into here – the main thing you need to know is that fixed rate penalties are usually higher than variable and linked to the remaining time in the term.

• If you pay off a variable rate mortgage, you’ll pay a penalty of 3 months interest for most mortgages – regardless of the time remaining on the term.

Reverse Mortgages – Key Differences On Penalties

Firstly, there is no amortization on a reverse mortgage since it is not paid back.

Unlike a regular mortgage, the term or the interest rate have nothing to do with the penalty amounts or calculations.

Penalties are determined by how soon after taking the reverse mortgage out that you pay it back – the earlier you pay it back, the bigger the penalty.

For example, the penalty for paying it back after 1 year will be bigger than the penalty after 2 years and so on.

Using the same chart that I provided for regular mortgages, here’s what a reverse mortgage might look like:

As you can see, you can still choose options 1 and 2 with a variety of terms and different reverse mortgage rate types with a reverse mortgage – much like a regular mortgage.

The difference is that there is no amortization, as the loan isn’t paid off – so you keep renewing into different 1-5 year terms forever (rather than 25 years, or whatever the length of the amortization was with a regular mortgage).

This is discussed in more detail in this article on reverse mortgage terms and interest explained.

Reverse Mortgage Penalties In Detail

The key thing to consider with a reverse mortgage is the first 3 years – this is when penalties are highest for paying it back.

After 3 years, the penalties reduce drastically and some of the lenders also offer an opportunity to pay it back at the end of year 5 with no penalty.

After 10 years, there are no penalties for paying off a reverse mortgage with any of the current lenders.

Reverse Mortgage Penalties – Exceptions

Again, as I mentioned at the beginning, if both homeowners pass away, there are zero penalties on a reverse mortgage.

In addition to this, the lenders may allow you to prepay a certain amount (usually up to 10% each year) – this works in a very similar way to regular mortgages, which also have prepayment options.

If the owners are moving into a retirement home or nursing home, then the penalties are on a reverse mortgage are reduced by 50%. This isn’t a common thing with regular mortgages.

Finally, one of the lenders at present offers an ‘open’ reverse mortgage that can be paid off with no penalty at any time – it does have higher rates and fees though.

Reverse Mortgage vs Regular Mortgage – Penalty Examples

Below, I’m going to walk you through some penalty examples, comparing estimates of a reverse mortgage penalty to a regular penalty.

In every example, to be consistent, I’m going to assume a $300,000 mortgage balance that’s being paid off, to make things simple.

I’ll run through some different examples – these are just estimates and approximations, as real amounts vary lender to lender – the purpose isn’t to show exact numbers but more to demonstrate everything I talked about above.

You’ll see that, in some cases, regular penalties are higher and in others reverse mortgage penalties are higher.

Example 1:

You’re at the end of year 12 of your mortgage, and 2 years into a 5 year fixed rate term. For example, you may have had 2 x 5 year terms (10 years) already before this one.

As noted above, reverse mortgage penalties are zero after 10 years. But with a regular mortgage you’ll still pay a sizeable penalty because the term and rate dictate these.

Example 2:

You’re at the end of year 7 of your mortgage, and 2 years into a 5 year fixed rate term. So you may already have had one 5 year term before this.

The regular mortgage penalty is the same as the previous example – it’s dictated by the term and rate. Since you’re at year 7 of a reverse mortgage, you’ll generally pay a lower penalty than at other times.

Example 3:

You’re at the end of year 7 of your mortgage, and 2 years into a 5 year variable rate term. The same as example 2, just it’s a variable rate mortgage.

This is an example of a good rule of thumb: variable rate mortgage penalties will almost always be lower on a regular mortgage than a reverse mortgage (unless the reverse mortgage is after year 10). The reverse mortgage penalty here is the same as the previous example – whether the rate is fixed or variable makes no difference. But a variable rate regular mortgage generally has a lower penalty than a fixed rate.

Example 4:

You’re at the end of year 2 of your mortgage, and 2 years into a 5 year fixed rate term.

The regular penalty is high because you’re exiting a fixed rate mortgage early in the term. The reverse mortgage penalty is also high because you’re breaking it in the first 3 years, when penalties are the highest.

Example 5:

You’ve just taken out a new mortgage and you’re at the end of year 1 of your mortgage, and 1 year into a 5 year fixed rate term.

This is similar to example 4 – the regular penalty is high because you’re exiting a fixed rate mortgage early in the term. The reverse mortgage penalty is also high because you’re breaking it in the first 3 years, when penalties are the highest.

Example 6:

You’re at the end of year 1 of your mortgage, and 1 year into a 5 year variable rate term. The same as example 5 but with a variable rate instead.

Even though you’re exiting the regular mortgage early, the penalty is much lower because it’s a variable rate. But the reverse mortgage penalty remains high as it’s dictated by how early you’re paying it off and because it’s the first 3 years, penalties are high. The fact it’s a variable rate has no influence on the reverse mortgage penalty in the first 3 years.

Example 7:

You’re at the end of year 5 of your mortgage and 5 years into a 5 year fixed rate term.

Regular mortgages can be paid off at the end of any term without a penalty. For a reverse mortgage, this isn’t the case as the number of years you’ve held it dictates the penalty. However, some lenders offer a one-time option at the end of year 5 to pay it off without penalty – so your penalty will either be zero (if you’re with one of these lenders) or the usual 5 year penalty (if you’re not).

Summary Of Reverse Mortgage Penalties

Reverse mortgages differ from regular mortgages in how penalties are calculated.

Rather than the rate type (fixed/variable) or term dictating the penalties, they are instead set by the amount of time you’ve held the reverse mortgage.

A good rule of thumb: if you are only considering holding a reverse mortgage for less than 3 years, you need to factor in the penalties – otherwise they should not be a major part of your decision.

And if you plan on living in your home for the rest of your life (or at least 10 years) with a reverse mortgage in place, then you don’t need to worry about penalties at all.

Get A Free Reverse Mortgage Assessment In 90 Seconds

I hope you found the above information on reverse mortgage penalties useful. If you’re considering a reverse mortgage, you should know that you can get a free professional reverse mortgage assessment – from a Chartered Accountant – who’ll then advise you if this is a good solution for you, or if something better works.

All it takes is 90 seconds – click here to get started.

Mich Sneddon, CPA, CA

A Canadian Chartered Accountant and licensed Mortgage Professional – creator of Reverse Mortgage Pros – the #1 reverse mortgage specialists in Canada.  I make it my mission to educate Canadians about how reverse mortgages work so that you can make an informed and educated decision that’s right for you and your family.