The long-struggling housing market is finally showing signs of recovery, giving many homeowners more equity in their properties. This is prompting more pre-retirees to consider if, and how, home equity can be turned into a source of cash to help fund their retirement.
Home equity represents one of the biggest assets for many Americans. However, there are risks in assuming that your home’s equity will be a guaranteed source of income in retirement. For starters, home equity, like any investment, is subject to the fluctuations of the market and may have tax consequences. Also, you will always need a place to live, so you can’t assume that the full value of a home is at your disposal. Remember that the primary function of your home is to provide a roof over your head, and using equity to fund retirement requires careful planning. Here are three primary options:
- Home Equity Lines of Credit (HELOC): A HELOCS (second mortgage) is a reasonable option for an employed individual, but it may be less practical for someone in retirement. HELOCs need to be repaid, and using the proceeds from a home equity loan to help fund retirement often means taking on interest costs in order to generate that income. It’s important to note that an individual puts a lien on their home by taking a HELOC, and risks losing it should he or she fail to repay under the terms of the loan.
- Reverse Mortgage: A popular alternative is a reverse mortgage. This allows a homeowner to tap into the home equity while still occupying it. A reverse mortgage provides payment to homeowners for the bulk of the value of their homes via a lump sum, a line of credit or periodic payments. In essence, this is a loan to the homeowner paid back when the house is sold at some future date. However, interest accrues throughout the duration of the loan and upfront fees apply, so it can be expensive.
A standard reverse mortgage, also called a Home Equity Conversion Mortgage, charges a 2 percent mortgage insurance premium on the full value of the home. The government now offers a lower cost “Saver” loan with a mortgage insurance premium of just 0.01 percent of the home’s value, but applying a higher interest rate. Over time, the combination of fees and interest charges can significantly deplete the value of the home’s equity.
Reverse mortgage applicants must be at least 62 years old. The older a retiree is, the more he or she can receive from the home’s equity. Understanding the complicated terms of a reverse mortgage before signing on the dotted line is crucial.
Selling & Downsizing: The other way to tap a home’s equity is to sell it. Many retirees are ready to “downsize” or to buy or rent a smaller residence. If the market is right, they can sell their existing home, buy a new place and have equity leftover to add to their retirement nest egg.
Michael W. K. Yee at (808) 952-1222 ext. 1240
Michael W K Yee, CFP®, CFS®, CRPC®, is a Financial Advisor and CERTIFIED FINANCIAL PLANNER practitioner™ with Ameriprise Financial Services, Inc. in Honolulu, HI. He specializes in fee-based financial planning and asset management strategies and has been in practice for 25 years. To contact him, michael.w.yee@ampf.com, 808.952.1222 ext 1240, 1585 Kapiolani Blvd., Suite 1100 Honolulu, Hawai‘i 96814.
Advisor is licensed/registered to do business with U.S. residents only in the states of Honolulu, Hawai‘i.
1 The Money Across Generations IISM study was commissioned by Ameriprise Financial, Inc. and conducted by telephone by GfK in December 2011 among 1,006 affluent baby boomers (those with $100,000 or more in investable assets); 300 parents of baby boomers; and 300 children of baby boomers at least 18 years old. The margin of error is +/- three percentage points for the affluent boomers segment and +/- six percentage points for the parents and children of boomers segments.
2 United States Department of Labor, Wage and Hour Division, Family and Medical Leave Act http://www.dol.gov/whd/fmla/
Ameriprise Financial and its representatives do not provide tax or legal advice. Consult with your tax advisor or attorney regarding specific tax issues.
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