Cheaper reverse mortgage alternatives: evaluate the pros and cons of each option carefully

Money Digest, Oct, 2002 by Talbot Stevens

In last month's Money Digest we introduced how reverse mortgages can be used by older homeowners to provide tax-free retirement funds. Now, let's explore some of the alternatives.

Those who own larger homes could downsize to a smaller home, condo, or an apartment. This is a simple way to access equity in the home, again with the proceeds from your principal residence tax-free.

If possible, most people would like to remain in their home where they have all of their family memories. Taking in a boarder is an option, especially if the tenant is a relative or friend. In addition to companionship, a young boarder could help with some of the house and yard maintenance.

For those who want to stay in their home without the privacy issues of taking in a boarder, there are other cheaper options that are more flexible than a reverse mortgage.

One of the benefits of a reverse mortgage is that the money you receive is tax-free. But the fact is that money received from any loan is tax-free, regardless of the collateral used to secure the loan.

Many people will consider a reverse mortgage to supplement their retirement income. One of the disadvantages of using reverse mortgages for this goal is that you receive a single lump sum. To produce an income that lasts for 10 or 20 years, you must purchase an annuity or invest that money and draw from it. In either case, a portion of the income -- the investment growth -- is taxable.

A more tax-effective strategy is to set up a Home Line of Credit (HLOC), and draw income as needed, using some of the proceeds to make the minimum interest payments. As with any loan, the money received is tax-free. Since the drawings do not count as income, this strategy might reduce the clawback of government benefits, such as the Guaranteed Income Supplement.

This approach is much cheaper not just because the interest rate charged on a HLOC is typically prime -- the lowest rate generally available -- but you only pay interest on the amount borrowed and you have the flexibility to draw income as you need it. Note that any source of collateral can also be used to secure a line of credit, including investments and life insurance cash values. By using a life insurance policy to secure a line of credit, you may be able to have the interest payments deferred until death, as with a reverse mortgage.

The downsides to drawing from a line of credit are that it cannot continue indefinitely, and if you draw too much, you could have to pay down the loan -- possibly forcing you to sell your home -- before you die. For a price, a reverse mortgage solves these problems,. allowing you to stay in your home forever without ever having to worry about payments, markets or interest rates.

As all of the strategies are difficult to change, you should evaluate the pros and cons of each option very carefully with a professional before proceeding.

Talbot Stevens is a financial educator, speaker and author of Financial Freedom Without Sacrifice. Phone (519) 663-2252.