Have you ever settled back in an armchair of an evening to enjoy a few "down" moments in front of the television, only to be jarred out of your relaxation, by the pernicious proposition of offering your home up for 40% of its value?  That's what the CHIP (Canadian Home Income Plan) reverse mortgage program proposes to senior Canadians who own real estate.  The offer is "up to 40 % of to-days' value of a family's home, in exchange for the ownership of it.  Tax free cash today, while the value of the home slips through the fingers of the senior property holder, and his estate forever.

This is what the widely supported CHIP reverse mortgage program holds out for the unsuspecting senior property owner.  The sponsoring banks will compound interest on the advanced funds until at the death of the property owner, the bank owns the wealth in the property, while the owner is left with nothing.  Not a pretty picture.

The need that this "product" is servicing is the fact that most Canadians will be property wealthy and cash poor in retirement. Is there something available through the investment industry that may address the need for more resources in retirement?  Is there perhaps a better deal for the seniors who need more cash in retirement? Would such an approach benefit the investment industry, and the planner profession?  In a word; yes.  A very powerful solution is "Investment Leveraging". There are a number of investment industry trust companies, chartered and near banks, who will advance funds for investment purposes which allow the senior property owner to create an investment portfolio that can be used to create a tax deferred pension, similar to the CHIP but without the limitations, and downsides.

The Method:
The way that the investment industry would facilitate a client application for leveraging would be to offer an investment loan using the investments as collateral.  The clients' real estate holdings would be used to support such an application as to net worth, but it would not be the intent of the investment lending firm to acquire or encumber the property.  These lenders are purely interested in the earning of interest income through the lending process and need as security a lean on the investments only.

A review of the typical investment loan application would quickly reveal that there are many options available to the client.  These options focus on structure, such as 100% financing or a "2 for 1" loan, debt servicing; interest only or interest and principal, and issues of liability; ie; "margin call" loans or "no margin call" loans, as examples.  For our purposes here of course we would suggest a "2 for 1" loan, with an interest only repayment schedule, and the no margin call option.  Why would we suggest such a thing?  The "2 for 1" loan incurs less interest charges than a 100% loan and is easier to arrange.  Interest only repayment means that approximately 60% of the monthly distribution is  available for our clients to use to enhance their lives, tax free, and of course the no margin option is a necessary protection, we would insist on.

The preferred investment would be a very low volatility, (low beta) cash disbursement fund, where the monthly cash disbursement would be used to pay the interest charges.  Two cash flow benefits would accrue to our client through this approach; the balance of the cash disbursement would be a "monthly tax deferred income" they could use to enhance their life in retirement, as mentioned above, and the interest expense from the investment loan would be tax deductible, providing an annual refund they could spend as well. This strategy allows the client to enjoy more of the "Go Go" years of their retirement.  That time in life when people are healthy enough to travel if they want, and could put some extra cash, on a tax deferred basis, to good use.        

Safety Issues
Every one asks; "But if they aren't paying on the loan they have put themselves into debt in a big way haven't they?"  The answer really involves a paradigm shift.  We would borrow money to pay for an education, or buy a home, why not to have a retirement?  Is it bad to have debt?  Are we morally less a proper citizen if we have an investment loan that we deduct on our tax returns? I would argue that we are being sophisticated in our financial planning.  Here's why.

When the client inquires with the bank about borrowing for investment purposes, the lender will typically come back that they will allow up to 75% of the value of the home.  We recommend that the client only use 50% of the value of the home so that there is a "cushion" of equity available.  This would be the "one" in our "2 for 1" loan.

We use exclusively one of the very low "beta" funds, (meaning low volatility) with a cash distribution, the effect of which is to provide a very secure cash flow which will fully service the loan.  Remember that the "return of capital", cash distribution, makes the cash flow tax deferred, or simply put the cash the client receives each month is not taxable in the current tax year.  In fact it is largely free of tax for at least a decade, at which point it faces taxes at the capital gains rate, the best tax rate we have in Canada.

Often when our clients consider borrowing to invest they think about the loan and the debt, but not the asset.  This is not a boat, or motor home, assets surely to depreciate, but an investment of the highest quality, most apt to appreciate over time.  These funds are invested in such assets as Government of Canada bonds, and Dividend bearing stocks, amongst the most secure investments available.  So, rather than having "consumed" the money borrowed, our client still has the investment in hand, in a very liquid form, since this investment is traded actively on the TSX.

What about the home equity portion of the borrowing that is secured by the clients' home?  As compared with the CHIP proposal, where the debt to the bank is allowed to increase through the addition of interest and fees on the debt, in this case because of the cash distribution, the loan is being serviced.  Few people would imagine that the house would be worth less in ten years than it is valued today.  So again while the debt stays fixed, the supporting asset is passively growing wealth for the client.

Finally, the loan is a "no margin call" loan, which means that any short term drop in the market value of the investments will not result in a demand for more money to increase the security on the loan. 

Conclusion
We use here the CHIP reverse mortgage for a "whipping boy" with apologies to the people who promote it to unsophisticated senior Canadians.  We in the investment industry need to stand up for our clients and help them get the best deal we can.  While in the CHIP offer our clients get a one time 40% for their homes, we are able to help them get 150% of the value of their home, by comparison, using the "2 for 1", example. While with the CHIP our clients will lose their homes over time; we help them make the most of the assets they have worked hard to acquire, and they never lose control of their home or their finances.  At death the client has a number of options, none of which force them to give up their home.  What with the tax deductible investment loan interest, the tax deferred income stream, the secure investments, and the no margin loans; we could help our clients move in their senior years from a diet of restricted activities because of cash flow and taxation issues, to the life of their dreams.

There is a joke I like to tell that refers to the concept of a troubled retirement, that I will share here for your edification.

An older lady went to her local grocery store one afternoon and asked the young clerk restocking the shelves, if he could help her find some cat food.

"Oh, I'm not allowed to sell seniors pet food, Ma'am", he sputtered, "My manager said that if any senior needed food we would be glad to pack a box for you, of real food."

"Seriously, I have a cat, what do you want me to feed it?"  the lady asked.

"I think you have to prove it, Ma'am", the young fellow replied.

So the lady left only to return later with a pretty angora cat in her arms.  She soon had left the store with the food she needed.  Some days later she returned, and asked the teenage clerk once more for help.

"Could you show me where to find dog food please?"

"No Ma'am! We aren't allowed to sell senior people any kind of pet food, if you need food we could get you a box of something nice, no charge." He offered proudly.

"Listen Sonny, I have a dog." The dignified lady bristled.

"Sorry but you have to prove it or I will get in trouble." The young fellow offered.

Later that afternoon the lady returned with a cute Pekinese, and picked up her dog food.  The very next day she returned with a small box in her hand, tastefully decorated and taped closed, that had a small hole in the top surface.

"Stick your finger in the hole here will you?" she ordered her young clerk.

"Is there something that will bite me in there?" he questioned.

"Of course not!" she replied.  So he complied. 

As he withdrew his finger, he recoiled at what looked like excrement on his finger.

"Is that poop?" he gasped.

"Yes," she assured the young man, "I need toilet paper today!"

The problem seems to be one of "SRO" fear of attention, and "file fattening" designed to secure the dealerships and the regulators from criticism rather than to provide the client with the best services and innovative solutions the industry could provide.  This is a call for us in the industry to apply our fiduciary obligation to our clients in an active way to help them have a life, rather than a "fixed income" existence.  The difference could be as much as the difference between a diet of cat food, and one of caviar.