There’s a good chance you’re inside one of your most valuable assets, one that can be a useful source of income in retirement. That’s right, your home.
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.
As a financial adviser specializing in retirement planning services, we know that creating a consistent paycheck in retirement is a top priority. Your home can be a valuable part of your retirement toolbox along with other income sources such as Social Security and your investment portfolio.
Here are three ways that illustrate the potential benefits – and risks – of using your home to support your retirement plan.
This article covers:
Using home equity for retirement income
As a homeowner, you have the option of using the equity in your home to borrow funds when needed. Banks typically let you borrow up to 75-80% of the equity in your home, either with a home equity loan or home equity line of credit (HELOC).
Home equity loans are essentially second mortgages that are taken as a lump-sum payment and repaid monthly with interest over a certain period of time. Whereas, Home equity lines of credit are revolving credit lines like credit cards.
Certainly, tapping your home equity is better than taking a consumer loan because the interest rates are generally much lower. So, this may be a good option for retirees who need emergency cash.
If you plan on retiring in your home, it can also make sense to use your home equity for any remodeling or repairs. the interest charges are generally tax-deductible if the loan is used to acquire, build or make capital improvements to your primary residence.
Some planners may say that you could shift to using home equity as an income source during times of market distress. This potentially allows your retirement portfolio to recover. But there are risks to this strategy, as well as for home equity loans in general, you should be aware of.
For one, you could lose your home, as it is used as collateral for the loan. Also, if your home’s value drops significantly, you could owe more than the house is worth. This would be a difficult problem if you then chose to sell the home.
Perhaps the biggest disadvantage for retirees is that it can disrupt your cash flow and reduces your future disposable income.
Downsizing to create retirement funds
As you age, downsizing can make sense for both your financial health and your physical well-being. Essentially, you sell your home and move into a more suitable-sized home that is also less expensive. The price difference between your old and new home could be a significant financial windfall.
You could then invest the proceeds to potentially increase the amount of income you generate from your investment portfolio over the course of your retirement. Also, living in a smaller home could help reduce your expenses. You can free up income as you allocate less money toward property taxes, maintenance, insurance and utility bills.
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 for additional income
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.
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.
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.
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 will also not be able to bequeath your home to your children.
Further, you may have to pay costly fees including appraisals, legal fees, origination fees, mortgage insurance and service fees.
If you move to a nursing home or assisted living facility for more than 12 months, you will likely have to sell your home. And, if your spouse is not listed as a borrower, he or she will likely be forced to move. Lastly, if you fail to pay property taxes and insurance, you’ll default on your loan, which could mean you will lose your home.
As an income source, your home is probably best looked at as a last resort. Whether to tap your home for retirement 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.
Instead, consider working with a financial adviser to help create a plan for building a sustainable income stream from more suitable assets, such as your workplace retirement benefits and Social Security.
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