For many of us, our homes will be one of the most significant investments of our lives. Some will buy a home in their 20s and continue to pay and invest in that home until they are at retirement. Others will buy, sell, and upgrade their homes several times. Others may rent a home their entire life. Our homes are more than just a place to live, they are where we raise our families and an anchor point in our lives, but they are also a significant investment. So how do we factor this large investment into our overall financial plan for retirement? First, let’s talk about options for the homeownership side, and then we will talk about the renter side.
When people talk about home equity, the amount of ownership you have in your home, what they are talking about is the walkaway value of their home—calculated by determining the market value (what you could sell it for) and subtracting the outstanding mortgage balance as well as any other outstanding liabilities against your home, i.e., Home Equity Line of Credit, second mortgage, etc. (basically what you owe). In general, as long as your home is well taken care of and the area you live in continues to grow and expand, it is expected that the value of your home will increase; now, this isn’t always the case. Look back to 2008-09 for a time when house valuations decrease dramatically. For this post, we will assume the former. Homeownership provides several options for using that home equity in your overall retirement/financial plan. There are many ways to tap into your home equity when needed. As a caution before we go into anything, remember that you are using your home as collateral, so failure to repay or keep up with the payments could result in you being forced to sell your home to repay.
- Home Equity Loans – these are commonly known as second mortgages. Most of us will take out a mortgage to buy a home, but as that home appreciates and we pay down, the mortgage equity begins to build up. You can then draw out that equity through a home equity loan that can be up to 80 to 85% of the equity amount in your home. While this wouldn’t be a lot when your first purchased your home, after 20 years, it could be a sizable amount. The loan would be paid in a lump sum and could be used for anything; repayment begins immediately after taking the lump sum. Home equity loans have many qualification requirements and would have closing costs to consider as well, but they could be a way of pulling funds out of your investment to use for other things.
- HELOC – A home equity line of credit would be another option to draw from to use your home to access funds. With HELOCs, there is usually a draw period where you don’t have to take a lump sum payment but rather draw down what you need. Usually, this draw period is around ten years, although it could be different. During the draw period, you typically don’t have to make payments, but if you do, it is reflected in your available draw balance. So basically, anything you pay back can be drawn again. HELOCs usually have variable rates tied to a benchmark, like PRIME, that can fluctuate up or down depending on what interest rates are doing. No interest is charged until you have made a draw, but it would end if you paid it all back. HELOCs are useful for the flexibility of drawing funds for unexpected high costs that pop up in retirement without having to liquidate investments or retirement savings to cover. Be sure to read the stipulations of a HELOC carefully before taking one out to make sure it will allow you to use the HELOC for what you intend.
- Reverse Mortgage – This is a loan for homeowners aged 62 and older who want to pull the equity from their homes without making monthly payments. These mortgages are useful for seniors who cannot meet their income needs but own their homes outright or have more than 50% equity. Reverse mortgages used to have a bad reputation, but the market has changed over the years to make them an option for some. Some drawbacks to think about before going this route. These loans do have a closing cost associated with them. Also, reverse mortgages require that maintenance on the property be up to date and kept up with during the life of the loan. It is also necessary for property taxes to be paid, as well as insurance on the home. Also, if your home has been the family home place for generations, then your heirs would need to be able to pay off the reverse mortgage in order to keep it. If your heirs are not in a place to do this or will put them in a more challenging financial position to hold on to, then some consideration should be given before making a move. If you need to move from the home, usually that will trigger the loan to be due as well, so it could limit other options moving forward because of the loan needing to be paid back.
- Home Downsizing – Selling your home and relocating to something cheaper and smaller gives you an opportunity to reduce your monthly housing expenses, but also gives you a chance to relocate either in the same area or to a new location that is either closer to family and friends, in a better climate, or lower cost of living. Since profits from your primary residents are shielded from capital gain taxes, the first $250,000 for an individual or $500,000 for a married couple selling a jointly owned home, the financial upside for downsizing could be significant for your retirement/financial well-being. You could also see if renting would be a more viable option rather than purchasing again.
- Rental income – Homeowners also have rental income options as well; with the creation of companies like Airbnb and VRBO, you now have opportunities to drive revenue by using your home or rooms in your home to help pull in extra income. While there would be several areas to consider before entering this arrangement it does allow an additional revenue stream that wasn’t available for many just a few years ago. Renting out your home could be done short-term or long-term, depending on what works best for your situation. You would also retain full control of your asset without putting your home up as collateral.
If you rent your home, you will not have equity to pull from in retirement. Many lifetime renters can be just as well or better off than someone who purchased a home. The key is to invest the portion that would have been spent on housing if you were to have owned a home. This is where you will need to do research and math to see what is the best option for you. Let’s say that you can rent your home for around $1,000 per month, and you live in an area where rent is controlled so that it doesn’t fluctuate much over the long term. In reality, this is not the norm. That monthly rent versus your down payment and mortgage would need to be cheaper or close to even, then calculate the maintenance cost, taxes, and insurance cost against the price for your rental and insurance. Now if you were to invest the savings in a long-term investment/retirement fund, then you would be investing to make up the difference of accrued equity in a home. This, again, is a very simplified example, but the key would be investing the difference in saving to make up for the appreciation of the home asset.
Whether we plan for it or not, your home will ultimately become part of our retirement investment strategy. Looking at your options and making them part of your strategy will allow you to take better advantage of those options before you get to the point of having to make a decision. Please talk with your family about the options before you go through with them. Discuss the reasons and the results of the decisions and options so that everyone is on the same page. You don’t want your heirs to think they will be inheriting your home only to have to sell it to cover the loans you took as part of your retirement plan. Ultimately it will be your decision on how to use your assets, but having everyone on the same page or at least aware of the situation will make the process easier.
