Using Home Equity for Retirement Income
February 10, 2013 by MJP
Filed under Downsizing
Surveys conducted by various financial services providers continue to show a disconnect between retirement reality and U.S. baby boomers. In a recent such survey, use of home equity as retirement income tool came front and center.
However, 37% of those polled reported that they were not on track to pay off their mortgage before they retired.
Assuming that there is some overlap between the “use home equity” group and the “I’ll still have a mortgage” group, there seems to be trouble in river city.
First, let’s consider how one would use home equity to fund retirement.
I see three strategies for doing this, depending on what you mean by “fund.”
First, you can borrow against your home equity via a home equity loan or line of credit.
That is not “funding” in my dictionary. That is simple borrowing. You will accrue interest on a loan that must be paid back. The only relationship between your retirement income and your home equity is that your home equity is serving as collateral and perhaps providing a lower interest rate.
What are the downsides of this home equity loan strategy? There are several.
First, you are creating debt that unsettles your peace of mind, something that most retirees value.
Second, you are paying interest.
Third, you are placing your entire home at risk if you cannot pay the loan back.
I don’t like it. Cross it off the list.
A second strategy for using home equity to fund retirement is a reverse mortgage.
This is also debt, with interest accruing. You don’t have to pay the debt off until you sell the house. But, you may not make it that far.
Reverse mortgages come with high fees. Moreover, you still have to insure and maintain the house and pay taxes.
If you are so cash challenged so as to require a reverse mortgage for income, you could go into default by struggling to pay the other costs of home ownership. If that happens, you lose your house.
I don’t like this either.
The final strategy for using home equity to provide retirement income is to cash out the home equity by selling your home. This is the strategy that works, if you are willing to downsize and pocket the difference between your net sales proceeds and your subsequent purchase price (or rental).
The downsizing strategy provides an extra benefit in that any gain on sale of your house is probably going to be tax free.
This is the strategy we are planning. We have lots of equity in this house. In a year or two, I want to sell this house and buy something for cash that costs no more than half what this house is worth. The surplus sales proceeds will be invested for retirement income.
We all remember 5-10 years ago when so many homeowners were pulling equity out of their homes like at ATM. those days are long gone. I wonder if the mindsets that created this environment have truly changed.
Here is a link to an article that discussed the Ameriprise survey.
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The third option explained is the most intelligent way to proceed, especially if you lost a significant amount when the market nosedived in recent years. I have never thought to include my home equity in my retirement plans–why? Because I plan to keep this house until I or my husband pass on. I have no desire to uproot myself as my children and brother live in the immediate area. Also, North Carolina is tax friendly to me personally because I get a special exemption when I decide to withdraw funds from my Thrift Savings Plan. I pay no state tax on withdrawals as a federal retiree as I come under the provisions of the Bailey Decision. If at some time my plans changed, I would certainly buy a property that would eliminate a mortgage payment alltogether. I would certainly love to be mortgage free as we do still have a small amount left but the necessities and bills are covered with the pensions and SS payments so I guess you could say we are in a good place and I won’t touch my TSP until age 70 1/2 when the IRS comes knocking.
As a Californian, living in Silicon Valley, I’m afraid we have to sell our house when retire. The median house price in my town is close to 2 million. Though we still have big mortgage, we have even bigger equity in the house. My husband and I are not government employees thus no pension. We have no way to pay off the mortgage by the time we retire. The property tax alone will be more than $30,000 by then. That will eat a big chunk into our retirement income. Not only we have to sell our house, we have to uproot, move out the area in order to be mortgage free.
Option three is by far the best alternative as it not only puts money in the persons pocket but it eliminates the additional costs of a HELOC and Reverse Mortgage. The fact that the sale proceeds is likely tax free is gravy.