The Dangers of Using Your Home to Fund Retirement
February 20, 2015 | Your Finances
As you near retirement, what if your biggest asset is the roof over your head? Tapping the equity you have in your home to meet your ongoing expenses might seem easy, but is it really a good idea? There are several things to consider before you put the for-sale sign in your front yard.
You Still Need a Place to Live
Most American workers today rely on a combination of resources during retirement. In fact, the Investment Company Institute reported in its 2013 Fact Book that homeownership is the second most important resource after Social Security.
Many older Americans either own their homes outright or have a relatively small mortgage compared to their home’s value. Retirees can benefit from homeownership simply by staying and living rent free. Alternatively, selling the home and downsizing can free up cash to meet retirement needs.
The strategy is pretty straightforward. For example, if you sold your house for $300,000 and replaced it with one costing $200,000, you would have $100,000 in cash to either spend or invest for your retirement needs. In addition, current tax law permits you to sell your home and realize up to $250,000 in tax-free profits ($500,000 if you are married filing jointly).
While downsizing can be an appealing option for those approaching retirement, it’s not always the right solution.
Many people have a deep attachment to their family home, which means there can be great resistance on the part of a spouse or even adult children to selling it. Also, many tend to overestimate the proceeds received from the home sale or underestimate the time required to sell.
Recent history has shown that the real estate market, just like the equities market, goes up and down. It is very difficult to predict how much your house will sell for in the future or how long it will take to sell at that time.
What’s more, housing regions don’t all move up and down in tandem. You may have a plan to sell your home in one region and retire to another region, but there’s no telling what the housing market may be like in that part of the country when you’re finally ready to make the move.
Also, selling your home may not free up as much cash as you think. After paying off any mortgage and selling costs, the cash available may be less than expected. Unless that cash is sufficient to provide a comfortable, long-term residence elsewhere, retirees should think twice before selling a home they like in a place they like.
The Risks of Leverage
For these and other reasons, many people prefer to stay in their home and “age in place.” Some plan on using the equity in their home for retirement either through a home equity loan or a reverse mortgage. Yet these strategies carry risks.
A home equity loan still needs to be repaid, even if the value of the house falls. If a home equity loan is not repaid, lenders may foreclose on the house and could potentially sue if the sale proceeds are not sufficient to pay off the loan.
In the case of a reverse mortgage, the payment stream is reversed—instead of making monthly payments to a lender, the lender makes payments to you, either as a lump sum of cash, as a series of payments or as a line of credit that you access as needed. How much you get depends on your age, the value of your home, and the costs and terms of the specific reverse mortgage agreement. Reverse mortgages can involve high costs and are not without risk.
Whether you take a home equity loan or choose a reverse mortgage, you’re still responsible for the costs associated with homeownership. You’ll need to insure and maintain your property and pay your real estate taxes. If you can’t make those payments, you could lose your home.
There may be times when using your home equity for retirement income may be justified. However, a better course for retirement is to craft a solid financial plan and then stick to it. That way, you may be able to use your home as a safety net, where the equity you’ve built up can be tapped only as a last resort.
If you decide to use your home equity to help in funding your retirement, however, make sure you thoroughly investigate your options first. A financial professional can help you weigh the pros and cons of each and help you create a strategy that will enable you to maximize all of your assets for retirement.