Will Your House Finance Your Retirement?
It's easy to understand how homeowners might think that their home is their ticket to a cushy retirement. Even though over time, stocks have outperformed real estate by a wide margin, homeowners tend to remember the good times — like annual gains of more than 12 percent for real estate from 2001 to 2006 — and forget the slack (or downright horrible) times for the housing market.
In reality, however, using your house as a piggy bank isn't always as easy or as attractive as it appears, says Glenn Ruffenach, coauthor with Kelly Greene of The Wall Street Journal Complete Retirement Guidebook. "That can be a much more difficult strategy than people imagine," he says. "I think a lot of Americans are looking at the equity in their homes as a way to make up for shortfalls in their retirement savings."
Living high on the house
"People see the equity in their house and say, 'I've always wanted to travel to Europe' or 'I've always wanted to buy a small place on a lake.' And so at a relatively young age, they're pulling out this equity to make some of these dreams come true," Ruffenach says. That can be risky if later in life you need to rely on your equity as a safety net to cover contingencies such as long-term care, much less to live on for day-to-day expenses, he says.
The bottom line: As of 2007, home equity was at its lowest level in 30 years.
Squeezing cash from your house
Homeowners can use a variety of strategies to tap the equity in their home. Unfortunately, each of them has potentially deal-breaking drawbacks for those expecting to use their home to finance their retirement. The three most common options:
Selling your home and downsizing. This strategy can backfire for retirees who have a strong emotional attachment to their home or who want to leave it to their children. For them, selling is not an option.
Taking out a home-equity loan or line of credit. These strategies offer the built-in advantage of tax-deductible interest. But for workers looking for a long-term cash-flow solution in retirement, they really aren't in the running because, as with any revolving debt, they have to be repaid on a regular basis.
Using a reverse mortgage. If you're a homeowner age 62 or older, you can essentially "sell back" your home to a lender in return for monthly payments, a line of credit or even a lump-sum distribution. You pay no taxes on the money you receive, and the loan doesn't have to be repaid until the house is sold (presumably when you die or move to an assisted-living facility). At that point, the house is sold and the lender is paid off (including interest and fees); if there's money left over after the loan is repaid (a big if), you or your estate gets the excess.
"Reverse mortgages can work well for some people, but there are caveats as well," says Ruffenach. "The fees are high and the loans are capped. So just because you're sitting on $300,000 worth of equity in your home doesn't mean a bank is going to give you $300,000. They might give you half that amount." There's also the possibility that your reverse mortgage could be called if you become delinquent on your property taxes or you don't keep up with routine maintenance.
Best-laid plans
Alicia H. Munnell, Ph.D., Director of the Center for Retirement Research at Boston College, hopes that the recent real estate downturn will serve as a wake-up call to prospective home buyers who may be tempted to buy more house than they can afford. "I think the softening real estate market will make people a little bit more cautious about how much housing they buy because [they realize] it's not the brass ring," she says. "I also hope it makes people more cautious about tapping their equity during their work life."
Ruffenach agrees, noting that the first baby boomers turned 62 in January 2008. "So the really big wave of retirees has yet to crash on the beach. But it's coming." His advice to that new wave? Try to pay off your mortgage before you retire. "It's one of the most important things you can do."
Take the next step...
Know where to turn. Tap into your home's equity with a home equity loan or home equity line of credit from the Principal Financial Group.
