What Should You Do With Your Home Equity In Retirement


The Hidden Benefits Of Downsizing

Using Home Equity in Retirement: Four Ways To Access Your Home Equity For Retirement Income

Many retirees decide to downsize in retirement, and doing so comes with potential added benefits â you can cut many home-related expenses. The Center for Retirement Research at Boston College found that empty-nesters were spending 30% of their income on property taxes, insurance, maintenance and utilities.3

The question for downsizers then becomes what to do with all of the unleashed capital. âThereâs no single right answer,â says Imundo. âYou and your advisor can look at all of the options to help figure out what might work best for what you want to achieve.â Then you can move on to focus again on the people and things that matter most to you â and create new memories, perhaps in new places.

1 Gallup, âWhat Percentage of Americans Own Stock?â August 13, 20212 U.S. Census Bureau, “Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2018,” September 20213 Center for Retirement Research at Boston College, âIs Home Equity an Underutilized Retirement Asset?â 2017

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You’ll Receive A Tax Break

Many retirees are afraid of selling their homes because they are unaware of the tax consequences of doing so. Thankfully, there are favorable tax laws that protect taxpayers that often minimize the tax obligation. Recent changes to capital gains tax legislation allow single taxpayers to exclude $250,000 of capital gains from their return. Married couples filing a joint return can exclude up to $500,00 of profit.

There are some rules around who can and can’t use this tax exclusion. In general, you’ll have to have lived in your home for two of the past five years before the date you’re selling your home. You can only take this exemption once every two years. There are also conditions where the exclusion is not valid the exclusion can not be taken on property that is not your primary residence or property acquired through a 1031 exchange.

How To Get A Home Equity Loan

Apply with several lenders and compare their costs, including interest rates. You can get loan estimates from several different sources, including a local loan originator, an online or national broker, or your preferred bank or credit union.

Lenders will check your credit and might require a home appraisal to firmly establish the fair market value of your property and the amount of your equity. Several weeks or more can pass before any money is available to you.

Lenders commonly look for, and base approval decisions on, a few factors. You’ll most likely have to have at least 15% to 20% equity in your property. You should have secure employmentat least as much as possibleand a solid income record even if you’ve changed jobs occasionally. You should have a debt-to-income ratio, also referred to as “housing expense ratio,” of no more than 36%, although some lenders will consider DTI ratios of up to 50%.

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What Role Should Your House Have In Retirement Planning

Home is where the heart is. And it can also be where the assets are. As of 2011, home equity made up about three-quarters of the average Americans net worth, according to the U.S. Census Bureau. Despite this high figure, the home doesnt always factor into retirement planning calculations.

For clients with ample assets, home equity is a less pressing issue. In that case, theres no reason to concern yourself with the house, said David Imhoff, CPA/PFS, owner of Cornerstone Wealth Advisors LLC in Overland Park, Kan., because we look at the house as the asset of last resort.

But retirees of more modest means may need every possible option, including home equity. Its really surprising that more people dont pay attention to it, said Geoff Sanzenbacher, Ph.D., research economist at the Center for Retirement Research at Boston College. The house can be a potential source of wealth.

Yet, according to a 2016 Urban Institute survey, only 6% of older Americans are interested in tapping their home equity.

Including housing wealthand sometimes the debt that accompanies itduring retirement planning can show clients a more realistic view of their retirement possibilities. At the very least, it can help them envision what their housing situation might look like and changes they need to make.

Our experts weigh in on the role that home equity plays in retirement planning decisions.

What Is The Best Way To Tap Home Equity

Should You Use Your Home Equity for Retirement Income?

The smartest strategy for accessing your home equity depends mostly on what you want to do with the money. Of course, your and your financial situation matter, too. However, they will be factors regardless of which option you choose. These choices usually match with the situations and goals listed below.

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How Your Home Equity Figures Into Retirement

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BOSTON — When it comes to planning for retirement, there are many, many questions to answer. But to Anna Rappaport there are just three that matter and perhaps one that doesn’t get enough attention: When should you retire? When should you collect Social Security? And what should you do about the equity in your home?

If you get the answers to those questions right, you’ve pretty much got retirement right, according to Rappaport, a former president of the Society of Actuaries as well a president of a Chicago consulting firm bearing her name.

Now, there’s plenty of information about the first two questions but not so much about the third. And that’s the one that people really need to get right now, especially given the findings of the SOA’s recent work on the subject. Here’s a snapshot of what Rappaport and her colleagues found:

What should you do with the equity in your home?

The equity in your home represents a big part of your wealth. If you’re married, your non-financial assets — mostly the equity in your house — represent about 70% of your total assets, according to a 2009 Society of Actuaries report “Segmenting the Middle Market: Retirement Risks and Solutions.”

Rappaport said that housing costs currently represents about 35% of a preretiree’s budget. And that means housing equity, as a percent of total assets, is perhaps more than twice what it should be.

Software fails to consider housing wealth
How to use housing wealth to finance retirement

Purchase An Investment Property

Then again, maybe you want to stay put and purchase an investment property. This can also improve cash flow and supplement your income.

If you dont want to use personal savings to finance investment properties, maybe pull cash from your home.

Refinancing is the process of getting a new mortgage to replace an existing mortgage. Its an excellent way to reduce your mortgage interest rate. And with a cash-out refinance, you can borrow up to 80 percent of your homes equity.

The downside:

You might not qualify for a lower interest rate. Also, youll have to pay closing costs again.

Refinancing can even extend the life of your mortgage. Many lenders dont allow mortgage terms less than 15 years.

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How An Equity Release Agreement Works

One option is for one or more investors to buy portions of your home’s equity through a property investment fund. You pay fees which are periodically deducted from the remaining equity in your home. The investor’s share of your home’s equity goes up over time, and yours goes down.

For example, suppose your home is currently worth $500,000. You sell 20% of your home’s equity in return for a lump sum of $100,000. The fee charged by the fund may vary, depending on your circumstances and the agreement. If the fund charges an initial fee of $30,000, it may take $130,000 of your equity to cover both the lump sum and periodic fee.

Additional amounts of equity are deducted each time the periodic fee falls due . The fee is a set percentage of the fund’s equity in your home. So, as the fund’s share of equity increases, the fee goes up.

When the equity release agreement ends, and your home is sold, the fund gets their share of the proceeds. That is, the proportion of your home’s equity they have accrued. You or your deceased estate get the remainder of the proceeds, if any.

The proportion of home equity you keep will reduce over time, and could even go down to zero.

Check your agreement to see what happens if your equity goes down to zero. Make sure you can continue living in your home, until sold by you or your deceased estate.

It Could Be An Emergency Fund

Should You Get a HELOC (Home Equity Line of Credit) Before You Retire?

Obviously, there are many options for making use of your homes equity and space in retirement. Most are better than taking out a HELOC or home equity loan.

But what if youre in a truly sticky situation? Could your homes equity turn into an emergency fund?

Maybe. If you have, for instance, unexpected medical debt, you could use your home as a temporary emergency fund.

This is a legitimate option if your choices are between taking out a high-interest credit card or personal loan and borrowing against your home at a much lower rate. However, youll need to keep certain potential issues in mind. For one thing, a personal loan doesnt put the roof over your head at risk.

Chances are, though, that any unexpected debt you incur during retirement can be negotiated without tapping into your homes equity. Most hospitals, for instance, will let you make payments on your medical debt, often with zero interest.

Are you still asking yourself should I take out a home equity loan in retirement?

If youre in this rock-and-a-hard-place type situation, borrowing some of your homes equity could make sense. Just make sure that you dont go underwater on your home. That way, if you need to sell it to get out of the loan later in retirement, you can do so.

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You Will Still Need A Place To Live

Remember, once you sell your home you will need to find another place to live. If you are planning to buy a smaller home to live in, you will have to contend with fees, taxes, and another mortgage, albeit presumably smaller than your previous mortgage. If you are planning on using the money from selling your home to pay for a nursing home, if youre married, your spouse will still need a place to live. The point is it is important to decide whether selling your home is worth it, considering the fees and the continued need to have a place to live. It may be more advantageous to remain in your current home.

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In the end, planning for retirement is an important part of your financial planning, and sometimes using home equity may be your best bet. However, it is vital not to be overly reliant on your home equity. Dont look at the current value of your home and think that will be enough to fund your retirement years. The value of homes and properties change, commission and taxes take their toll, and the necessity to have a place to live will persist into your retirement. Make sure to take all of this into account when planning your golden years.

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No Longer Free And Clear

Perhaps the first decision retirees need to make is whether to carry a mortgage. It used to be a given that a mortgage would be paid off by retirement, but thats less true today. Between 1998 and 2012, the proportion of seniors carrying a mortgage rose from 23.9% to 35%, according to Fannie Mae. Not only are more retirees carrying a mortgage, but they also owe more than in the past. According to a report from the Center for Retirement Research, using data from the Federal Reserves Survey of Consumer Finances, from 2001 to 2013, the housing debt-to-income ratio rose by 52 percentage points for Americans 55 and older, while it grew by a much lower rate for younger households.

Practically, that means they need more money for retirement, and they have to do something more than what theyve been doing to this point, Sanzenbacher said. Some retirees should consider downsizing as a way to reduce housing expenses, Sanzenbacher said. Others might want to postpone retirement so they can make more headway on their mortgage, he advised.

Even clients who have the cash flow to continue mortgage payments have an aversion to debt in retirement, CPAs said. People cant imagine not going to work every day and getting paid while they still have this debt to pay off, said Kelley Long, CPA/PFS, a resident financial planner with Financial Finesse in Chicago.

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What About Reverse Mortgages

A reverse mortgage, or “home equity conversion mortgage” , is a type of home equity loan for people 62 and older that converts a portion of home equity into cash. The lender makes payments to the homeowner, who maintains ownership of the home throughout his or her life. However, there are nuances to reverse mortgages, and the terms and conditions should be considered carefully since they affect your beneficiaries. In addition, because lenders require that you live in the home as your primary residence, youll need to repay the loan if you want or need to move.

When Paying Off Your Mortgage May Make Sense

How home equity can boost your retirement income for life

There may be good reasons to pay off your mortgage. It can save you thousands of dollars in interest, depending on the current size of your debt, and give you peace of mind that no matter what happens in the future, you own your home outright. Paying off your mortgage may make sense if:

  • You have substantial retirement savings, especially if the funds you’d be withdrawing are in a taxable account and are not earning much interest.
  • You’re downsizing. If you’re planning to sell your home for a smaller one, you can apply the equity to your new home, resulting in a modest mortgage or perhaps no mortgage.

Your mortgage is a factor in your retirement income plan and can affect your quality of life.

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When To Tap Home Equity

While tapping into your home equity to help fund your retirement is a viable option for many, understanding your unique financial situation and how much it will realistically cost you to live in retirement is the first step in creating a foolproof plan for your future.

Overall, using home equity toward retirement works best for those with a high level of equity in their home. It can help you secure your next property purchase, provide opportunity to capitalize on investments or pay down debts, and help grant you long-term financial security.

On the other hand, tapping into your home equity as a form of income can be potentially hazardous if youre not fully aware of how the process works and what the potential outcomes could be. Its important to remember that your home is not a liquid asset, and you should always avoid using equity in a manner that creates an unaffordable situation.

As with any big financial decision, you should work with a financial adviser to create a plan and strategize scenarios that will help you stay financially independent into and through retirement.

David Mount is a director with the Wise Investor Group at Robert W. Baird & Co. in Reston, Va. Baird does not provide tax, legal or real estate advice, and does not provide or service mortgages.

Other Ways To Tap Into Your Homes Equity

In an emergency, a reverse mortgage can help you make the most of your homes equity. While a reverse mortgage is likely the most-marketed way to make use of your homes equity in retirement, its not necessarily the best.

You can tap into your home and its equity in other ways, too, including:

  • Home-sharing Models like Airbnb could allow you to pay for your mortgage. Or if your mortgage is paid off, home-sharing could give you the extra money you need to live comfortably. Plus, being a home-sharing host can be a fun way to make new connections from around the world!
  • Renting your home Dreaming of a retirement where you travel? Consider renting out your whole home. You can use the rental money, fewer expenses, to fund your adventures. Then when youre ready to settle back down, youll have a house to which you can come home.
  • Downsizing The most common way to tap into a homes equity during retirement is to downsize. If you owe $20,000 on a home worth $150,000, you can easily sell the home and pay off the mortgage. Then youve got $130,000 to work with. You could probably buy a smaller home in the same area, or even move to a more affordable location. Buying a cheaper home with those funds gives you a stable place to live and extra money to live on.

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Option : Become A Landlord

It may not be a huge investment to turn part of your home into an apartment with its own kitchen, bathroom, and entrance. Or, you can rent out your entire home for all or part of the year, rent a smaller unit yourself, and pocket the difference.

Pros: You can cover or offset your housing costs with rental incomeand postpone selling your home for longer than you might otherwise be able to.

Cons: Youll have to deal with all the headaches that come with having tenants. Be ready for 3 a.m. phone calls, and have enough cash in reserve that the apartment or home can be vacant between renters.

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