House Rich but Nest Egg Poor? Use Your Home Equity

In the last two years, many American consumers have personally experienced being house rich but cash poor.  In other words, they occupy (and have title to) a house that may be worth a lot of money, but the mortgage, taxes, insurance, and maintenance costs eat up 50% or more of their income.

The dilemma that some baby boomers have is that they are house rich but nest egg poor.

By this I mean that most of their net worth is tied up in their home equity.  Any investments and other assets make up a relatively small component of their retirement nest egg.   The good news is that they actually have equity because many homeowners do not.  The bad news is that residential housing values may remain flat for an extended period, providing little or no capital gain (return on equity) to a baby boomer who is anxious to rebuild that nest egg in the next 5-10 years.

As I have suggested before, even though home values are down, this still may be a good time to downsize and pull some of that equity out to invest. Moreover, the law still allows a married couple to exclude up to $500k on a sale of a principal residence from taxable income.   Congress has already begun diluting the capital gains exclusion by changing the rules on sales of second homes.   It would not surprise me if a Democrat Congress makes further changes to that tax law in the coming years, perhaps by phasing out the exclusion based on income.  That would hurt a lot of people.

If I were in a position where most of our retirement nest egg comprised home equity, I would give serious consideration to making a change. If you sold and spread the surplus sales proceeds into relatively safe tax – advantaged investments, you are likely to come out better than if you sat on a home that was not increasing in value.  If you are afraid of getting back into the stock market right now (and who could blame you), considering using the sales proceeds to start a retirement emergency fund, using I-Bonds or even properly diversified municipal bond funds issued by a stable state or local government.

If you are wondering if being “house rich and nest egg poor” applies to you, this is what I would do:

1.  Estimate the current market value of your home.

2.  Using your estimated home value, subtract any mortgage balance to determine your net home equity.

3.  Calculate your net worth but don’t include the home equity you calculated or your mortgage balance for this calculation.

4.  Subtract from your net worth any assets that you cannot use as part of your retirement nest egg.

5.  Run your retirement nest egg assets through a retirement portfolio analysis.

6.  Estimate your Social Security retirement benefits using your annual Social Security statement or the online Social Security benefit estimator.

7.  Taking into account the results of your portfolio analysis, your Social Security benefits, and any pension benefits, ask yourself if you are happy with your anticipated retirement income.  If not, proceed to the next step.

8.   Estimate the cost of a new home you could purchase with cash if you downsized.  Subtract that amount from the amount of home equity you calculated, giving you a surplus cash amount.

9.  Repeat Step 5, this time adding the surplus cash amount into the retirement portfolio analysis, using an appropriate hypothetical investment consistent with your asset allocation and risk tolerance.  This could be as easy as using the surplus cash for a hypothetical re-balancing of your current investments.

10.  Repeat Step 7.  If the results are a lot more pleasing to you, you are a good candidate for an immediate downsizing strategy.

After 2008 and beyond, it’s time to think outside the box to plan for retirement.  That box may be your present home.

Image credit:  Svilen Mushkatov

FREE UPDATES: If you enjoy what you read here, please consider subscribing to receive free updates automatically by RSS feed or by email. (I promise that your email address will not be shared or used for any other purpose.)