For many retirees, home equity – the amount of the home you own – is their largest store of wealth. Most two-person households with couples age 65 and older have higher levels of home equity than financial assets, according to a report by the Center for Retirement Research.
As pension plans dry up and workers on average underfund their retirement accounts, it’s more important than ever for retirees to have multiple income streams, and to know how to use them.
Your home can be a valuable part of your retirement toolbox along with other income sources such as Social Security and your investment portfolio. You can use it as an emergency fund or to bequeath to your children. Generally, there are two ways to use your home for income in retirement. You can move to a less expensive home, known as downsizing. Or, you can take out a reverse mortgage, which is like taking out a loan on your home.
As an income source, however, your home should be a last resort. For one, there are potential costs and risks involved. More important, your home has more than financial value. It’s where you feel safe and where you’ve grown as a family and created memories. In many ways, your home is a part of who you are. Therefore, you should thoroughly weigh your options to see what is right for you.
Downsizing Your Home
As you age, downsizing can make sense for both your financial health and your physical well-being.
How downsizing can turn into income
- Invest the proceeds and increase your income stream. The price difference between your old and new home could be a significant financial windfall. Investing the proceeds can increase the amount of income you generate from your investment portfolio over the course of your retirement. You may also be able to lower the income you need from your savings and other sources.
- Reduce your expenses. A less expensive home generally means lower living expenses. You can free up income as you allocate less money toward property taxes, maintenance, insurance and utility bills.
- Find a home better suited for your needs. If you’ve been in your current home for many years, it may have an unfavorable layout – too many stairs and rooms – and may be located in an area that is no longer attractive – near schools or offices that you no longer need. Downsizing gives you the chance to relocate to a home and neighborhood that matches your retirement lifestyle. You can find a home design that is more accommodating to your physical abilities, which may help you avoid the expenses of staying in a nursing home or remodeling your current home. You may also find a neighborhood closer to the things you want, such as family and friends, social activities and medical facilities.
Of course, the downside of downsizing is that you must move from your home. You will also be unable to pass it along to your children, unless they decide to buy it from you.
Taking a Reverse Mortgage
Those who want to stay in their current home but still need additional income may consider a reverse mortgage. Essentially, a reverse mortgage is a loan that uses your home as collateral.
There are different types of reverse mortgages available from many providers. However, those who apply for a reverse mortgage will likely get a Home Equity Conversion Mortgage through the Federal Housing Administration, which is available to those who are 62 or older. It is the only reverse mortgage insured by the U.S. Federal government.
Reverse mortgages are heavily advertised and marketed, so it may seem as if they are a common retirement option. But, that’s not true. A 2015 report by the University of Southern California found less than 1% of Americans age 62 or older had taken out a reverse mortgage.
The reality is that most retirees don’t need to implement a reverse mortgage as an income strategy. The complexity, costs and risks involved make it a decision you should consider very carefully. Be sure to thoroughly research the terms and the loan provider.
Benefits of a reverse mortgage
A reverse mortgage allows you to stay in your home without making any loan payments while you use the equity to fund your retirement expenses. You only repay the loan when you move, sell the home or pass away. Additionally, since a reverse mortgage is a loan it isn’t considered income. Therefore, you don’t pay taxes on the money nor will it affect your Social Security or Medicare benefits.
Ways to use a reverse mortgage
A reverse mortgage can be paid out in various ways including as a line of credit, a lump sum or as monthly payments. Depending on how you choose to receive the money, it can be used to:
- Cover unexpected or everyday retirement expenses
- Pay off your existing mortgage to lower your expenses and free up income
- Remodel your home to suit your changing standard of living
- Create a reliable income stream in the form of regular payments for life or a predetermined time period
Drawbacks of a reverse mortgage
While a reverse mortgage can provide additional income without having to adjust your budget or lifestyle, you should be aware of the potential costs and risks.
- The amount you owe, plus the interest, reduces your home equity. It will not be available later if you need cash for an unexpected emergency, such as medical care or home repairs. You may want to consider paying off your mortgage and preserving the equity you have in your home for when you really need it.
- You cannot bequeath your home to your children.
- You may have to pay costly fees including appraisals, legal fees, origination fees, mortgage insurance and service fees. These fees can make many reverse mortgages much more expensive than other income options.
- If you move to a nursing home or assisted living facility for more than 12 months, you will likely have to sell your home. If your spouse is not listed as borrower, he or she will likely be forced to move.
- If you fail to pay property taxes and insurance, you’ll default on your loan, which could mean you will lose your home.
Home is where the heart is, and for some retirees, it’s also a place to find income. Whether to tap your home equity for income is not an easy decision. Make sure you understand the consequences and look first at your other income sources, such as your portfolio, before doing so.