A member of my Inner Circle recently asked us whether a reverse mortgage would be a good way to tap into the equity she had built up in her home.

Reverse mortgages in Canada typically let homeowners (age 60 or older) borrow on their home equity (maximum 40%). The loan and accumulated interest are repaid only if the house is sold (or if the borrower moves out) or from the proceeds of the estate. Generally, the borrower will get between 28% and 33% of the value of their home, depending on their age and the location and type of home.

Reverse mortgages in Canada: Look closely at the costs

We see reverse mortgages as appealing only in highly specialized circumstances. You’d want to use a reverse mortgage only if you feel that selling your home is out of the question, AND if you’ve exhausted all sources of income or funds (such as RRSPs, RRIFs, stock sales) that do not involve heavy costs, such as loss of tax deferral or a big tax bill.

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Before taking out a reverse mortgage, make sure you consider all other housing or financial options open to you. If none of these are appealing, you should then consider the costs of the reverse mortgage. What are the initial costs, such as the application fees and the house appraisal? What are the ongoing costs and the interest rate? What are the exit costs (i.e., is there a penalty for getting out of the plan early, are there additional legal fees or real-estate fees)? You’ll need to seek out and pay for independent legal advice, as well.

There are simpler options than reverse mortgages

If you are only planning to hold on to your home for a few extra years, it may be a lot cheaper to take out a mortgage-backed line of credit. If you plan to hang on to a home for a longer period, a reverse mortgage may be your only way of doing so. But keep in mind that the interest on a reverse mortgage compounds, just like the interest on a strip bond.

In fact, instead of “reverse mortgages,” it might be more accurate to call these deals “reverse savings accounts.” That’s because you are applying the much-acclaimed “magic of compound interest” to a debt rather than an asset.