The Biggest Mistake You Can Make With A Reverse Mortgage

Lately, I’ve noticed that many people are making the same mistake when it comes to their reverse mortgage decisions.

This mistake is choosing a short reverse mortgage term of 6 months, 1 year, 2 years, or even 3 years.

This can be a costly choice, and in this blog post, I’ll explain why selecting a short term could be the biggest mistake when it comes to reverse mortgages.

At the end I’ll also answer an important question that you might be considering: what term (6 months, 1 year, 2 year, 3 year, 4 year or 5 year) should I choose?

If you only want an answer to that question, you can jump to the end – but it might make sense to read the article to understand why I am making the recommendation that I am.

It’s important to understand why a short-term option might not be a good idea, especially in the current market environment.

As always, you can watch a video overview on this or read the full article below:

Firstly – What Is A Reverse Mortgage (In 20 Seconds)

A reverse mortgage is a financial product designed for homeowners aged 55 and older.

It allows you to borrow money against the equity in your home without requiring any monthly mortgage payments.

You can access 10% to 55% of your home’s value, with the actual amount depending on your age, property type, and location.

However, any existing mortgage on your home must be paid off first using the reverse mortgage funds.

This product is specifically designed to help you tap into your home’s equity to support your retirement and continue living in your home without the burden of monthly payments.

If you haven’t already got a copy, the best place to get started is with my free reverse mortgage guide that you can download here.

The Biggest Mistake You Can Make With A Reverse Mortgage Today

The most significant mistake you can make when choosing a reverse mortgage today – in my opinion – is selecting a short-term option.

Currently, interest rates on short-term reverse mortgages (such as 6-month, 1-year, or 2-year terms) are approximately 1 to 1.5% higher than the rates for a 5-year term.

By opting for a shorter term, you’re voluntarily agreeing to pay up to 1.5% more in interest.

This decision can end up costing you more money over time, so it’s crucial to understand the implications before making this choice.

Reasons To Select A Short Term

There are typically only two reasons why you might be considering a short-term reverse mortgage despite the higher interest rate:

1. You believe that interest rates will decrease in the near future, allowing you to renew at a lower rate.
2. You plan on selling your home or paying off the reverse mortgage at the end of the shorter term.

However, both of these reasons can lead to costly mistakes.

In the following sections, I’ll explain why these strategies might not work in your favor.

Planning On Selling Your Home Or Paying Off The Reverse Mortgage

Starting with the 2nd reason I listed above, many home homeowners believe that choosing a short-term reverse mortgage will allow them to avoid penalties if they sell their home or pay off the mortgage early.

While this strategy works with regular mortgages, it’s not how reverse mortgage penalties are calculated.

With a reverse mortgage, penalties are based on how long you’ve held the mortgage – not on the term length.

The penalty for a reverse mortgage after 1 year is exactly the same whether you were on a 1 year term or 5 year term

The term does not matter at all – in fact, the penalty to break a reverse mortgage is the same after 1 year whether you’re on a 1 year, 2 year, 3 year, 4 year or 5 year term – it does not matter, the penalty is the same.

(If you are in this situation, aside from finishing this section below, you are also going to want to check out my article and video: Breaking A Reverse Mortgage – Switching Lender, Refinancing Or Paying It Off )

Reverse Mortgage Penalties

I also have a detailed article and video where I walk you through this in more detail, including example calculations and comparing penalties to regular mortgages – you can get that here: Reverse Mortgage Penalties Explained

But the key point is that the length of the term has no impact on the penalties, unlike regular mortgages.

This means that if you plan on selling your home or paying off the mortgage early, taking a short-term option won’t save you money on penalties.

Instead, you’ll be paying up to 1.5% more interest and facing the exact same penalty anyway.

If you are in this position, I believe this is a very easy decision for you: take the lowest rate you are offered – regardless of the what the term is (since the term does not matter and won’t impact the penalty when you do eventually sell your home or pay off the reverse mortgage).

Choosing A Short Term, Expecting That Rates Will Come Down

The other reason that I see for choosing a short term, are folks who are doing so in the hope that rates will come down before they renew.

I can see the reasoning behind this – particular in a time where interest rates have come up and the natural expectation is that they should start to come down.

The media also help to convince people that this is the case (something that I’ll address below).

While this strategy may seem reasonable, there are three reasons why I believe that it is flawed and potentially a huge mistake:

1. The Lender Will Apply A Rate Premium At Renewal

All lenders currently apply a rate premium when you renew a reverse mortgage at the end of term.

What I mean by this is that they take the current rates being offered at the time you renew and add on a percentage amount (premium).

This premium isn’t applied to new customers, and it can range from 0.3% to 0.6%, or even as high as 2% in some cases!

This means that when you renew your reverse mortgage at the end of the term, you’ll likely get a higher interest rate than new customers, who are offered the current market rate.

This isn’t just the case with reverse mortgages but with regular mortgages too – almost all lenders will try and squeeze out an additional few percentage points on their rate at renewal since moving mortgage is a hassle and most people just renew with their existing lender to avoid having to deal with it.

But this premium can quickly eat into any savings, making the short-term strategy less beneficial than it might initially appear.

And even without the premium, you still need to consider the next point:

2. Rates Have To Come Down A Lot To Make It Worthwhile

If you’re paying 1.5% more interest for a short-term reverse mortgage, interest rates need to decrease significantly – by around 0.8% to 1.2% – for you to save money in the long run.

However, it’s rare for interest rates to fall that much within a year.

In 10+ years of helping Canadians with reverse mortgages I can only think of one or two times where I’ve seen this.

Generally speaking, over the course of a year interest rates don’t move as much as people think they do and this is particularly the case with reverse mortgage rates where the lenders tend to not change their rates so often and take their time before making rate moves.

This means that you’re ‘paying’ (there are no payments with a reverse mortgage but the interest is still a factor you should consider) a big price at up to 1.5% additional interest for 6 months to 2 years and hoping that you’ll get this money back in future savings.

It is – in my opinion – a risky strategy that might not pay off.

On top of that:

3. Not Only Might Rates Not Go Down Enough – They May Even Go Up

It’s important to remember that no one can predict future interest rates with certainty.

Even if analysts and the media are predicting that rates will decrease, these predictions are often incorrect.

Here’s an example:

This headline looks like it could have been written today, last month or anytime.

I see similar headlines and rhetoric in the media on a regular basis.

This headline and article was actually written in March 2023 – in the spring of 2023, many analysts with predicting rate cuts that summer.

But what happened by the summer was that inflation got worse and the Bank of Canada actually ended up increasing rates (twice).

(I discuss this exact example in my video (exclusive video on my channel, there is no article for this one): Should You Wait For Rates To Come Down?)

This is a good example as to why paying 1.5% more interest based on the hope that rates will go down is a costly gamble that could end up costing you more money in the long run – it is very hard to accurately predict what will happen with interest rates.

Summary – The Biggest Reverse Mortgage Mistake

Selecting a shorter-term reverse mortgage and paying a rate that’s up to 1.5% higher than longer-term options is one of the biggest mistakes you can make, in my opinion.

A shorter term has no impact on the penalties you’ll pay when selling your home – or paying off a reverse mortgage through other means – so is not an option you need to consider if this is what you are planning on doing (instead simply choose the lowest rate term).

If you are thinking about taking this option hoping that you can renew into a better rate then it’s important to know that if interest rates do come down, they would need to decrease significantly – by at least 0.8% – for the short-term strategy to be worthwhile.

Rate premiums applied at renewal will also eat into any potential savings on the renewal rate as well.

And, of course, rates could always go the other way – no matter what analysts or economists are saying.

It’s important to carefully consider these factors and make an informed decision when choosing a reverse mortgage term.

So, What Term Should You Take (If Not 6 Months, 1 Year Or 2 Year)?

I believe that the decision is simple: take the lowest rate offered to you, regardless of the term. If it is a close decision (there is less than 0.5% difference between the rates being offered), then go with the longer term, The reason behind my recommendation is the premiums that are added at renewal (as discussed above) – these premiums make choosing a longer term a better option because you delay the amount of time before they are applied and maximize the time you get the better ‘new customer’ rate.

Get A Free Professional Reverse Mortgage Assessment In 90 Seconds

I started Reverse Mortgage Pros to help people like you understand reverse mortgages – to make an educated and informed decision if they are right for you.

As part of this service, I also offer a free assessment to help you determine whether a reverse mortgage is the right solution for your financial needs.

Included in this, I will recommend a lender (if applicable) and show you all the hidden costs with all the lenders – including the renewal premiums that I mentioned above.

This free assessment only takes 90 seconds – simply click here: Get A Free Professional Reverse Mortgage Assessment

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.