The long-struggling housing market is finally showing signs of recovery, giving many homeowners more equity in their properties. This encouraging trend is likely prompting more pre-retirees to consider if, and how home equity can be turned into a source of cash to help fund their retirement.
There was a time when owning a home with little or no outstanding mortgage balance was considered a potential financial bonanza for those in retirement. For years, home values moved higher, sometimes dramatically so. But starting in 2006, the bottom fell out of the housing market. Home equity was decimated and homeowners changed their expectations about the role equity can play in retirement.
Even with a lower value, home equity continues to represent one of the biggest assets for many Americans. It may play an even more important role when retirement savings come up short of expectations. Some already retired or approaching retirement feel like they have little choice but to tap the equity they've built in their home to support their cash flow needs throughout the rest of their lives.
The question then becomes how to do it. There are a variety of options available, but the right answer for you may depend on what plans you have for living arrangements in the future and many other factors.
Finding the Most Realistic Solution: There are risks in assuming that the equity you've built up in your home will be a guaranteed source of income in retirement. For starters, you will always need a place to live, so you can't assume the full value of a home is at your disposal. Here are three primary options those in retirement generally consider:
Home Equity Lines of Credit (HELOC): Americans became accustomed to tapping their equity through HELOCS in the last 30 years, and though it is a reasonable option for an employed individual, it may be less practical for someone in retirement. HELOCs need to be repaid, and using the proceeds from a home equity loan to help fund retirement income needs often means taking on interest costs in order to generate that income. It's important to note that an individual puts a lien on their home by taking a HELOC (second mortgage), and risks losing it should he or she fail to repay under the terms of the loan.
Reverse Mortgage: An alternative that has become popular with many retirees is to use a reverse mortgage. This allows a homeowner to tap into the equity of the home while still occupying it. A reverse mortgage provides payment to homeowners for the bulk of the value of their homes via a lump sum, a line of credit or periodic payments. In essence this is a loan to the homeowner paid back when the house is sold at some future date. However, interest accrues throughout the duration of the loan and upfront fees apply, so it can be expensive.
A standard reverse mortgage, also called a Home Equity Conversion Mortgage, charges a two percent mortgage insurance premium on the full value of the home. The government now offers a lower cost "Saver" loan with a mortgage insurance premium of just 0.01 percent of the home's value, but applying a higher interest rate. Over time, the combination of fees and interest charges can significantly deplete the value of the home's equity as it applies to income needs. Individuals who qualify for a reverse mortgage must also be at least 62 years old. The older a retiree is, the more he or she can receive from the home's equity. Understanding the complicated terms of a reverse mortgage before signing on the dotted line is crucial.
Selling Your Home and Downsizing: The other way to tap a home's equity is to sell it. Many retirees find they are ready to "downsize" their living quarters to a smaller home, townhome or condo. If the market is right, they can sell their existing home, buy a new place and have equity leftover to add to their retirement nest egg. Alternatively, they can pocket the full proceeds from the home sale and rent their living quarters or explore other living options. This will greatly bolster their retirement savings, but it also adds a new monthly expense they will need to fund throughout the rest of their retirement.
Home equity offers great potential value in retirement but, like any investment, is subject to the fluctuations of the market and may have tax consequences. If you plan to tap your home's value to support your retirement, proceed with caution. Remember that the primary function of your home is to provide a roof over your head, and using equity to fund retirement requires careful planning.
Rocco is a Private Wealth Advisor with Ameriprise Financial Services, Inc. in Southampton, NY. He specializes in fee-based financial planning and asset management strategies and has been in practice for over 20 years. Advisors is licensed/registered to do business with U.S. residents only in the states of NY, NJ, TX, MA, PA, NC, NH, UT, NV, CA, NM, WA, VT, MS, MD, RI, FL, MO, SC, GA, MN, CT, AZ. Ameriprise Financial Services Inc., and its representatives do not provide tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation. Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC. www.roccocarriero.com
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