Do you know what is home equity and how to use it in retirement?
For most of us, our home is more than four walls and a roof. We spend so much time there that no wonder there is a strong emotional connection between you and your home.
That is why it is hard to think about your home as a financial asset. But depending on how much home equity you have built over the years your home might be one of your most useful retirement assets.
For people like me who are close to retirement, the question appears more often than ever whether to sell or keep the family home.
I would love to remain in our house full of memories where we raised our daughter, celebrated holidays with friends, and lived the big portion of our life. The separation would be hard. But besides the emotions, the decision to stay or move could mean financial risk or financial security in retirement.
According to the Federal Reserve Bank of New York, the average 65-year-old has 47 percent more debt today than a 65-year-old had in 2003. And based on recent studies, only 1 in 3 retirees are confident that they have enough money saved for a comfortable retirement.
I read several articles pointing at the gloomy picture of today’s workers to be at risk of having insufficient retirement funds. Outside of 401(k) and IRA plans, Americans saved very little for retirement.
However, there is one bright spot in this picture – home equity.
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 you are considered a homeowner, but 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 $550,000, and you have a remaining mortgage of $250,000. Thus, your current home equity is $300,000. This amount of equity in your home belongs to you.
$550,000 – $250,000 = $300,000
During a healthy real estate market, when the prices are rising, your home goes significantly higher in value. So, you will build equity without any efforts on your part.
I always check the market value of our home on a website like Zillow. It helps to see how it appreciated over the years. So, if your home value has grown from $550,000 to $600,000, you will get more equity in your home.
$600,000 – $250,000 = $350,000
You can increase home equity by paying down your mortgage and/ or taking steps to increase market value through home improvement projects. If you like to watch home remodeling shows on the HGTV channel, you can learn the ways to improve the value of your home. However, any of these projects will require extra money to pay for the improvement.
Even though we live in our homes, home equity is considered a financial asset. There are several ways to put that asset to work If you decide to use your home equity.
Here is how to use your home equity in retirement:
Downsize, buy a smaller house or condo, and invest your remaining funds.
We are emotionally connected to our home. Owning a home is like ‘being in a long-term relationship’. But homeownership comes with huge financial responsibilities.
If you are approaching retirement and do not have enough money saved, downsizing will be the easiest way to get access to extra money through your home equity.
After selling your home, you will receive home equity from the sale proceeds. Although, you will not be able to get all the money from your buyer if you still have a mortgage. When you sell a house with a current mortgage, the buyer’s fund will pay off to a lender whatever is remaining on your loan. In addition to that, you will have to pay realtor fees, taxes and spend some money on moving out.
For people who decide to downsize, the capital gain tax exemptions of $500,000 for a married couple and of $250,000 for a single person still works. However, there are certain rules if you want to qualify. Your house should be your primary residence, and you have to live there for two of the five years before the sale.
The important step is to decide how to use the money released from the sale of your home. You can use some of your equity to buy a smaller house or condo.
Moving from a home valued at $500,000 to one that costs $250,000 should give you extra cash. Then you can use the remaining $250,000 ($500,000 – $250,000) to increase your retirement savings or invest them into the stock market to receive an additional income.
Eventually, downsizing should help to save more money and give more financial freedom in your golden years.
Moving from a sprawling 3,500 square feet family home to a 1,000 square feet condo will help to reduce the cost of living. Housing cost is one of the highest retirement expenses. That is why most people choose to downsize because they want to reduce their monthly expenses while living on a fixed retirement income.
Just remember that if you do not have enough money saved for retirement, downsizing will help you to get extra cash to fund your retirement years. But be careful when thinking about how to put to work extra money released from the sale of your home.
Eventually, you will need to choose between 3 options if you decide on downsizing:
- Relocate or stay in your town?
- Rent or buy?
- A single-family home or condo?
Any option you choose, downsizing will help to free up money you can use to improve your retirement lifestyle for years.
Sell your home and move somewhere more affordable.
Another way to use your home equity is to sell your home and relocate to a more affordable place.
Where do you want to live when you retire? Are you living in a home that you cannot afford?
Relocating to a place with a lower cost of living will help to reduce your monthly expenses and stretch your retirement savings. In addition to that, 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.
Sell your home, move out, and live on rent.
Most people prefer to live in their own homes because of feeling safe and independent. There is a long list of pros and cons to both renting and buying. However, there are still many reasons for renting 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 instead of buying a new condo, you can stretch your retirement savings for longer.
When you are older and an empty nester, you do not need to live in that big house. You need less space, and you want somebody to take care of it. In addition to that, renting instead of buying a new home can significantly increase your retirement savings.
After the sale of your home, you will end up with an extra pot of money that can be invested for an additional income or spent to enhance your lifestyle.
Sell your home and move abroad.
Are you looking forward to setting up a home somewhere new? Life in retirement should be full of new adventures.
Retiring outside of the US is becoming a popular option among many baby boomers. When choosing a retirement destination, it is important to choose a country where the cost of living is low enough so you can stretch your retirement savings.
One of the most important factors to decide is how affordable your new place to live for years.
It is hard to imagine that many baby boomers can afford to retire in Italy or France. These countries are rich in culture, art, history, and food, but they are not cheap.
However, countries like Ecuador, Mexico, Costa Rica, or Panama can offer American retirees’ low cost of living, reliable healthcare, and 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.
Stay in your home and take out a reverse mortgage to fund retirement.
Many people would prefer to stay in their homes and retire in place. They want to remain in their neighborhood for life. In this case, a home-ownership might provide several options to fund your retirement without the risk of stock market investments.
One of the options is a reverse mortgage.
‘A reverse mortgage is a loan available to homeowners, 62 years or older that allows them to convert part of the equity in their homes in cash’. In simple words, as an older homeowner, you will be allowed to borrow money against the value of your current home.
A reverse mortgage is also known as a home equity conversation mortgage (HECM). It provides income to retirees 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 to move out. But 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 an 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. So, make sure to do your research to understand all the pros and cons, and talk to a loan specialist.
Putting It All Together
Over the years, your home was providing a safe haven for living your life. But it also has become your largest financial asset that increased in value.
If you are getting closer to retirement, you need to plan how to maximize every asset you have. Since the fear of running out of money in retirement is still present among many retirees. Your home can give you a huge financial advantage, especially, if you have built up significant home equity.
When you retire, that money can be converted into retirement income, cash for everyday expenses and hobbies, or financial leverage for long-term care. Explore the ways you might want to use your home equity in retirement.
Have you enjoyed this post? Make sure to hit that sign up button for more blog posts like this!
Disclosure: This information is only educational. This post intends to provide a simple guideline for an extremely complicated matter. I am not providing any specific financial advice or recommendations to any of my readers.