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Reverse mortgages are an idea whose time has come

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Expect reverse mortgages to become a more integral part of retirement planning over the next few decades

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Pension experts often talk about the “three pillars” of retirement income (government-sponsored plans, employer-sponsored plans and individual savings).

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The amount of retirement income that each of these pillars represents has (and will continue to) change over time, impacting pensioners’ financial security and standards of living.

Over the last few decades, the future of government-sponsored plans in Canada has become less certain (due in part to people living longer).

Likewise, employer-sponsored defined benefit (DB) plans have also struggled with funding, not only due to people living longer, but also due to asset return assumptions that turned out to be overly optimistic.

Lastly, the third pillar (individual personal savings) has also diminished significantly over the last few decades. Should these trends continue, many retirees will be forced to search for additional sources of income in order not to become a financial burden to their children.

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However, as “traditional” personal savings rates have languished, residential real estate values have been doing the exact opposite (despite the housing market crash of 2008/2009). At the same time, home ownership in in Canada is near all-time highs. The combination of these factors will likely open the door for reverse mortgages to become a more integral part of retirement planning over the next few decades.

A reverse mortgage is essentially a loan product geared towards older homeowners who have significant equity in their home (usually at least 50%) and are looking to borrow against it. In Canada, they can be offered to homeowners as young as 55.

Typically, the homeowner receives funds either as a lump sum, a fixed monthly payment, or a line of credit.

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As financial vehicles go, reverse mortgages are relatively young (first arriving on the scene in the US in the 1960s, and then later in Canada). During their first few decades, they suffered from their fair share of scams and predatory practices. Today, there are strong regulations in place to protect consumers and reverse mortgages represent a reliable source of accessible (and non-taxable) home equity, without having to sell or downsize.

And while there has been strong growth in this industry, we’ve estimated the penetration ratio of reverse mortgages in Canada to be about 0.2%, which means there is lots of room for growth, especially because Canada has a bit of catching up to do in comparison with other parts of the world.

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Recent metrics and historical growth aside, there is little doubt that general demographic trends alone will slowly but surely increase the popularity of reverse mortgages.

This raises some interesting considerations for the future. In recent years, economists and the media have often discussed the financial legacy that the baby boomers will leave behind as “the largest transfer of assets in human history”.

Naturally, much of this wealth accumulation was driven by real estate values. What will higher utilization of reverse mortgages mean for younger generations who are counting on their inheritance, and what will this mean for social programs the economy in general?

For now, we can only say that as reverse mortgages continue to grow in popularity, we should prepare for their impact on different areas of the economy. This should include consumer education efforts as well as the on-going review and improvement of regulations in order to continue making the industry less predatory and more accessible.

If used prudently, reverse mortgages can be a valuable financial tool to help fill the income gap left by insufficient government and employer pensions.

John Melinte is a partner with Sky View Suites a Toronto-based furnished rentals firm. Visit http://www.skyviewsuites.com

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