Q&A: Pension won’t be enough
Question: I am approaching early retirement and feel that my teacher’s pension plan will not be enough to live comfortably on. My house is almost paid off and if I really scrimp it should be very close to paid off by the time I retire. I am interested in borrowing money on the equity of my home and investing it. Is this the same as a reverse mortgage? What do you think of this idea? – S.B.
Gordon Pape answers: A reverse mortgage is one way to borrow against the equity in your home, but not the only way. There are a number of possible ways to do this.
The first, and the one most commonly used, is to set up a home equity line of credit (PLC), using your house as collateral. Every financial institution offers these plans and the interest rates are low, usually prime or prime plus one-quarter percent. Your rate can vary from one month to the next, depending on what happens to the prime rate. You will be required to make monthly payments against your PLC. Repayment terms will vary; some companies are willing to accept interest-only payments but most require a blend of principal and interest, as with a conventional mortgage.
The second possibility is to simply refinance your existing mortgage to the maximum the lender will permit. Your home has probably increased substantially in value since you set up the original mortgage so this would free up a lot of cash to invest. The advantage of this approach is that you can lock in an interest rate for several years, if you wish. Again, monthly payments will be required.
A reverse mortgage differs in that no monthly payment is needed. Interest on the loan accrues and is added to your principal. The entire amount becomes payable when you sell the house or die. The advantage of the reverse mortgage is that you won’t have to pay the lender a large percentage of the investment income you earn each month. The disadvantages are that you’ll pay a higher interest rate and the amount you can borrow is much less (a maximum of 40 per cent of the appraised value).
In all cases, if you invest the money the interest cost will be tax-deductible.
Borrowing against your home equity in your situation only makes sense if your net after-tax cash flow exceeds the out-of-pocket costs of servicing the loan. You’ll have to do your own calculations to see if such a plan would work for you. I hope you’re a math teacher!
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