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Dale Jackson

Personal Finance Columnist, Payback Time

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Ask people what their greatest single financial fear is and one answer will dominate: losing a home. For most of us our homes are the foundation we build our lives on – literally. They are our ultimate security, and that's why a home is like no other investment.

It's often this mix of fear and sentiment that makes considering a reverse mortgage difficult for retired homeowners. But when you weigh the facts, a reverse mortgage might be the perfect financial plan for some. Others would be best to avoid it, and for others there are better alternatives.

A reverse mortgage is a cash loan against the equity in your home. The homeowner receives lump sum or regular monthly tax-free payments from a lender. It's considered “reverse” because the payment stream flows in the opposite direction of a conventional mortgage. Instead of  paying the bank, the bank pays you.

Homeowners 55 years old or older can access up to 55 per cent of the home’s appraised value based on its age, location and type.

You cannot lose your home with a reverse mortgage. The title remains in the homeowner’s name, and the amount borrowed – plus the interest accumulated – is due only when the home is sold, or if the homeowners move out. When the homeowners die, it is transferred to the estate.

There are two main risks that come with a reverse mortgage: interest rate and housing market fluctuations. A spike in interest rates could bring the amount leveraged on the home above 55 per cent. At the same time, a drop in the value of the home would lower the equity portion, making the leveraged portion even higher.

The interest rate charged on a reverse mortgage is usually higher than conventional mortgage rates.

Like conventional mortgage rates, interest owing is added to the balance and compounded semi-annually. Homeowners have the option to not pay any back, pay down some or all of the interest annually, or repay in full at any time.

Homeowners can move or sell at any time but there are penalties for leaving the plan early.

There are a few costs (other than interest) tied to a reverse mortgage, including a general administration fee. Homeowners must also obtain independent legal advice and an independent home appraisal.

There are cheaper alternatives to a reverse mortgage. One is for retirees to sell their homes, invest the cash and rent another home. Another is to sell to a landlord and rent the same home.

But perhaps the best alternative is a secured line of credit against the equity in the home. Borrowing against a home gives the owner ultimate control over the amount borrowed and the repayment terms. The homeowner must still pay legal and appraisal fees but interest rates are normally much lower than a reverse mortgage. However, it's important to know that the dual risks of interest rate and housing market fluctuations still exist.

Homeowners who consider spending some of the equity in their homes should discuss the matter with family members and a qualified financial adviser.