Retirement
Substantial Home Equity Provides Options When Entering Retirement
Upon retirement, many people find themselves in the enviable position of having highly appreciated home equity at a time in life when income from employment ceases. Decisions on utilizing this untapped asset can be complex because each person's circumstances are unique. Variables such as age, health, liquid wealth, the location of family and friends, lifestyle, and hobbies all play a role in determining the best course of action.
This article, the second in a series, discusses two common approaches to converting home equity into retirement income: downsizing by selling the home and establishing a less expensive living situation, or staying in the home, accessing its appreciation through a reverse mortgage.
When downsizing, the retiree sells the home and uses the assets to purchase a less expensive home with lower maintenance costs, or he or she rents a home. The retiree must weigh the advantages and disadvantages of home ownership and of renting. Purchasing a new home allows the retiree to continue to enjoy the comfort of home ownership and preserves the option of tapping into home equity through various types of loans. The disadvantage of this approach is that the retiree still has ongoing maintenance costs and other burdens of home ownership. Renting frees the retiree from these worries and offers flexibility in location and lifestyle. However, rent outflows will continue and probably increase as time goes on.
When downsizing, the retiree's income needs are supported by the assets remaining after the sale of the appreciated home. Assets can be invested in a portfolio of securities that provide income and some of the assets can also be used to purchase an immediate annuity, which provides lifetime income.
The second approach utilizes a reverse mortgage. A reverse mortgage allows the retiree to receive regular payments secured by the value of the home and assures the retiree that he or she can remain in the home for life. Unlike a conventional mortgage or a home equity line of credit, no payments need to be made as long as the retiree remains in the home. In addition, the payments received are not treated as taxable income. The major disadvantages of this approach are that eligibility does not begin until age 62, costs for reverse mortgages are high, products are complex, and the value of the assets left to heirs is diminished upon sale of the home and repayment of the reverse mortgage from the sale proceeds.
If a decision is made to access home equity in retirement, most retirees can expect a small to modest percentage increase to their cash flow in exchange for some reduction in expected inheritance to their heirs. Discussions with independent and objective advisors can assist people in sorting through the relevant issues so that decisions can be made to keep them on track and aligned with goals.
The next article in our series will discuss another alternative for using assets from a highly appreciated home, which is to buy into a retirement community.