Four Ways to Use Your Home Equity in Your Retirement Plan | Personal finance


If you’ve carefully considered your retirement plan and aren’t entirely confident that you’ll be able to generate the income you need, it may be time to add your home equity to the mix. . There’s more than one way to leverage the equity in your home to support your retirement, using options like a home equity loan, home equity line of credit (HELOC) or reverse mortgage.

What is home equity?

home equity is the amount of property you have in your home. You can calculate the equity in your home by determining the market value of your home and subtracting your mortgage balance (plus any other liabilities, such as a home equity loan). If you have $100,000 left on your mortgage and the estimated market value of your home is $400,000, your home equity is $300,000.

Home equity is usually a big chunk of a retiree’s money net value— or the value of all your assets less all your debts. And your ability to finance your retirement using your home depends on the equity in your home.

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According to the US Census, two-thirds of the median net worth of households aged 65 and over comes from the equity in their property. In 2017, the median home equity for those 65 and older was $170,000. This can help solve many retirement funding problems, right?

“Clients often view the equity in their property as their most important asset, says Elijah Kovar, financial adviser at Great Waters Financial’s office in Richfield, Minnesota. “Some want to leave their children with an earning home while others see it as a safety net they can tap into in retirement if the need arises.”

How to Use Home Equity for Retirement

There’s no better way to leverage your home equity for retirement. It all depends on your personal situation.

Home Equity Loan

A home equity loan– also known as a second mortgage – allows a homeowner to cash in some of the equity in their property. Lenders will generally allow you to borrow up to 80% to 85% of the equity in your home.

With a home equity loan, you get a lump sum cash payment when you open the loan. Home equity loans are fixed rate loans and you must start repaying the loan immediately. The typical term for home equity loans is five, 10 or 15 years.

You can use the money for anything, but never lose sight of the fact that you have pledged your house as collateral. If you miss the payments, the lender may force you to sell the home to cover the loan balance. It’s an argument for only borrowing what you need to fund important projects, not bucket list trips.

If you’re looking forward to aging in place, for example, but need to make renovations to make your home safer and more comfortable for a senior, a home equity loan or HELOC, explained below, could be a smart option. . Also, if you use the money to improve your home, the interest you pay on the home equity loan may be tax deductible.

A home equity loan requires you to complete certain qualifying steps. Your interest rate depends in part on your credit score, and lenders will ask you questions to make sure you have the income to repay the loan. There may also be closing costs for a home equity loan.

Home equity line of credit

There is no lump sum payment when you purchase a home equity line of credit, commonly referred to as HELOC. Instead, you get a line of credit that you can use anytime during the initial phase of the HELOC, called the Draw Period.

A common drawdown period is 10 years, although it can be longer. You do not have to repay the money borrowed during the draw period, but if you do, your available line of credit will be readjusted to reflect the repayment.

HELOCs are generally variable rate loans. This means that the interest rate you are charged depends on the movement of the underlying benchmark used by your lender. No interest is charged until you use part of the credit line. If you’re concerned about rising interest rates, you can look into a fixed-rate hybrid HELOC, where you can convert the money you’ve borrowed to a fixed rate while retaining the flexibility to make future drawdowns at a variable rate.

As with a home equity loan, if you use the HELOC for a home improvement, you can deduct the interest payments on your federal tax return. You may be able to find a HELOC with no closing costs.

When looking to borrow money against your home equity, a home equity loan will likely have a slightly higher interest rate than a HELOC. Recently, the average HELOC rate was 4.7% and the average home equity loan rate was 5.7%. But remember: HELOC interest rates are generally flexible, while home equity loan interest rates are locked in for the life of the loan.

Kovar recommends retirees consider a home equity line of credit “for added flexibility” if a significant cost arises. But for planned expenses, for example for a renovation, a fixed rate mortgage is the safest route. “If you need a long time to pay the money back, you don’t want the HELOC variable rate popping up,” he says.

It is also important to understand that banks have the right to freeze home equity lines of credit during the drawdown period. It’s not common, but it happened during the financial crisis, when some banks became even more nervous about falling home values. Owners who had a HELOC and wanted to use it were out of luck.

Reverse Mortgage

A survey by Fannie Mae found that less than half of seniors said they were familiar with reverse mortgages. But even if you know how they work, you can be careful. In the same survey, 20% of participants said they feared “getting scammed” if they took out a reverse mortgage.

In the past, reverse mortgages got a bad rap because they were often marketed as a carefree way to put more money in your pocket, without carefully explaining the risks.

It’s a different market today. The vast majority of reverse mortgages are insured by the Federal Housing Administration (FHA). And in recent years, the FHA has imposed rules that better protect borrowers for its reverse mortgages, which it calls Home Equity Conversion Mortgages (HECM).

Recently, financial planning retirement experts and academics have taken to reverse mortgages and HECMs, publishing research that shows how using a reverse mortgage can be a smart way to generate more income. retired.

That said, there are a lot of moving parts to a reverse mortgage, including potentially high upfront costs and guidelines on how much time you can spend away from home. You might want to consider hiring a financial planner who knows the HECM program to help you determine if it’s right for you. Many planners will accept a project for a fixed or hourly fee.

Downsizing at home

Before you start making plans for aging in place, consider the benefits of moving. For starters, it’s possible to lower your monthly housing costs, although this of course depends on where you’re moving to. Could you find a smaller, cheaper place in the same area, or are you in the market for a big move somewhere cheaper and more climate-friendly?

There is also the possibility of pocketing enough profit on the sale to have money to add to your retirement investments. Keep in mind that the first $250,000 of profit, or $500,000 for married couples selling a condominium home, is exempt from capital gains tax.

Analyze the numbers with a financial planner to see if it makes sense to buy a new home or rent instead.

Should you use the equity in your home for your retirement?

Since the equity in your home makes up such a large portion of your net worth, it might make sense to use some of it to bolster your retirement security. But only if you manage the risks.

If you don’t meet the terms of the lines or loans, you may be forced to sell your home. To avoid this risk, consider downsizing to reduce your permanent housing costs and perhaps generate profits that you can reinvest for retirement income.

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