A lender’s promise of fast cash and no monthly payments make reverse mortgages an attractive alternative for cash-strapped seniors who are house-rich but cash-poor. Offered to homeowners over the age of 62 (in Canada), reverse mortgages allow seniors to convert the equity of their home to finance living expenses, home improvements or other needs. It seems like a good idea, but it could cost a fortune.

While they offer distinctive advantages - such as allowing people to stay in their home, receive a monthly income and maintaining an enjoyable standard of living - reverse mortgages aren’t for everyone and they involve a number of risks that should be taken into consideration. A reverse mortgage is the opposite of a conventional mortgage. Instead of borrowing money from a lender to buy a home, the lender pays you based on your home equity. The home must be your principal place of residence. If the mortgagor (homeowner) dies, sells the home or otherwise changes principal residence the initial loan must be paid back together with accrued interest, usually through the sale of the property. Because the proceeds of a reverse mortgage are classified as a loan rather than income, they are non-taxable.

The mortgage principal amount is anywhere between ten to forty percent of the home appraised value and is in direct function of the borrower’s age, current interest rates and property value.

With eighty percent of the average Canadian seniors’ assets tied up in their home and little or no income, this can be a viable financing tool for some people. The downside of a reverse mortgage, however, is that it can quickly eat up the accumulated equity of the house. Let’s say you take a $50,000 reverse mortgage today at the rate of five percent. You will owe $50,000 seven years from now, double in fourteen years. For seniors who want to leave one-hundred percent of their estate with heirs or who hope to have a certain amount of equity leftover after re-paying the mortgage, this type of financing may not be ideal.

When considering whether or not to take out a reverse mortgage, it is important to understand the risks involved, the types of reverse mortgages available and the different terms offered by lenders. And it never hurts to seek the advice of a third party such as a lawyer prior to entering into an agreement.

Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.

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