Do you know that your home is your biggest financial asset because of the home equity?
Over the years, your home has provided a haven for living your life. But it also has become your largest financial asset that increased in value. For many future retirees, home equity will be the biggest asset to fund their retirement lifestyle.
If you are getting closer to retirement, you need to plan how to maximize every asset you have. Your home can give you a huge financial advantage, especially if you have built up your home equity significantly.
When you retire, that money can be converted into retirement income, cash for everyday expenses and hobbies, or financial leverage for long-term care. No matter where you decide to live in retirement, the sooner you consider how to handle your real estate assets, the better prepared you will be.
What is home equity?
Home equity is a portion of your property that you ‘own’. When you purchased your home, you probably paid only 10 or 20 percent as a down payment and borrowed the rest of the money from the bank. Even though you are considered a homeowner, the bank owns the portion of your home until you pay off the loan.
How home equity works.
Home equity is the market value of your house minus what you owe. For example, the current market value of your house is $650,000, and you have a remaining mortgage of $250,000. Thus, your current home equity is $400,000 and this money belongs to you.
$650,000 – $250,000 = $400,000
When the prices are rising, your home goes significantly higher in value. So, you will build equity without any effort on your part. For example, if your home value has grown from $650,000 to $700,000, you will get more equity in your home.
$700,000 – $250,000 = $450,000
You can increase home equity by paying down your mortgage and/ or taking steps to increase market value through home improvement projects.
How to use home equity to fund your retirement?
If you decide to use your home equity, there are several ways to put this asset to work. But before deciding how your home can help you live the life you always wanted in retirement, calculate how much equity you have and whether your mortgage is paid off.
1. Downsize: trade your existing home for something smaller in size.
Selling your home is the most direct way to unlock the equity you have built in your house for decades. Keep in mind that downsizing can save you 35 percent or more on future housing costs.
Moving from a sprawling 3,500 square feet family home to a 1,000 square feet condo will help you reduce your cost of living. Because less space means less money, less maintenance, and less hassle. And the smaller the space the easier it will be to furnish and decorate.
You can spend the saved money on something more important such as travel, hobbies, and time with your family. After all, a smaller space has more value not only for your wallet but for your lifestyle.
The important thing to remember is that if you do not have enough money saved for retirement, downsizing will help you get extra cash to fund your retirement years.
For example, you carry a $100,000 mortgage. If you want to sell your home for $600,000, then downsize to a $350,000 smaller home or condo, you might walk away with a nice profit. Furthermore, you can buy your next smaller home with cash, without having to take out a mortgage.
High mortgage rates can be a problem.
If you have a mortgage on your current home with a low-interest rate and are looking to downsize and borrow money for your next home, keep in mind that the rate you can get will be much higher than your existing one.
Mortgage rates remain high in a current market. And they are highly unlikely to return to the rock-bottom levels of 2020 and 2021. If you are planning to finance your new home, it will be significantly more expensive than it was a year ago.
If you are already retired and live on a fixed income, downsizing will give you some significant savings down the road. But you have to compare it with how much interest you will pay over the time of the loan.
Furthermore, qualifying for a mortgage might be a problem if you are not working. Keep in mind that most mortgages are issued and approved based on your income and not on your assets. If you are not working, it will be harder to get financing because you cannot show the constant stream of your income.
2. Trade your existing home for something less expensive.
Another way to use your home equity is to sell your home and relocate to a more affordable place.
Relocating to a place with a lower cost of living will help you reduce your monthly expenses and stretch your retirement savings. Moreover, if you live in an expensive town, you can sell your home, buy a much nicer house in a cheaper area, and still have a big chunk of cash to live off.
By moving to a less-expensive area, you will have more funds for travel, hobbies, activities, etc. And if your home is fully paid-off, it can free up money for the purchase of a less expensive home and perhaps a mortgage-free lifestyle.
But be honest with yourself. When you consider using your home to fund your retirement, figure out if starting a new life in a different place and a new location is for you.
3. Sell your existing home and rent.
Some people like the idea of selling their current home first, giving them the option to rent while deciding where to buy the next one.
There is a long list of pros and cons whether to rent or buy. However, there are still many good reasons to rent when you retire. One of the main reasons for you might be to increase your retirement funds. So, if you decide to sell your home and live on rent, you can stretch your retirement savings for longer.
Renting for a long time is not an ideal solution. But not everyone has a clear idea of what they want right away. So, you might want to rent temporarily and live in several places before purchasing a home.
4. Think outside of the box: sell your home and move abroad.
Retiring outside of the US has become a popular option among many baby boomers. A big reason is that many baby boomers didn’t save enough for retirement or their retirement nest egg lost value and never recovered.
When choosing a retirement destination, it is important to find a country where the cost of living is low enough so you can stretch your retirement savings.
It is hard to imagine that many baby boomers can afford to retire in Italy or France. These countries are rich in culture, history, and art, but they are not cheap. However, countries like Ecuador, Mexico, Costa Rica, or Panama can offer American retirees a low cost of living, reliable healthcare, and a decent public transportation system.
Moving abroad is not for everyone. But if you are looking for adventure in your golden years, you can live a more pleasant and comfortable lifestyle at half of the cost than retiring in the US.
Other alternatives to downsizing.
5. Get HELOC or a home equity loan.
There is a proven fact that most people would prefer to stay in their homes and retire in place. They want to remain in their neighborhood for life. In this case, homeownership might provide several options to fund your retirement without the risk of stock market investments.
If you need extra cash but do not want to sell your home, you can apply for a home equity line of credit (HELOC) or a home equity loan (lump sum). Both options will allow you to borrow up to 80% of your home’s equity. Closing costs with both can be cheaper, and you can get a repayment term as low as five years.
But if your home is paid off, any kind of loan means that you will have a new mortgage on your home.
Before taking any concrete steps, analyze your current and future finances. Calculate what your income is likely to be and the sources of that income.
6. Get a reverse mortgage (HECM).
If your home has gained a lot in value, look at the numbers and see if it might be cheaper to stay put and take out a reverse mortgage.
A reverse mortgage is also known as a home equity conversation mortgage (HECM).
There are many benefits of getting a reverse mortgage. It provides you with regular income and does not require monthly payments. You still have to pay taxes and home insurance, and you will be responsible for maintenance. The best part is that you will receive a portion of your home equity in cash without requiring you to move out. However, the loan has to be repaid when the owner leaves the house.
A reverse mortgage can be flexible, and you can take HECM as a line of credit (HELOC), lump sum, or annuity.
One option is to use HECM for your medical or long-term care expenses late in life when you run out of money. Another option is to set up an annuity to increase Social Security and any other retirement income you will receive.
Reverse mortgages can be complicated. There are many terms and conditions, and it is a relatively expensive way to borrow money. Before going this route, do your research to understand all the pros and cons, and talk to a loan specialist.
Read more: Retirees Should Consider Reverse Mortgages
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