People often retire only to realize their retirement savings aren’t enough to support their lifestyle. However, there is a source of retirement income that many people overlook — their house. Home equity can help with retirement if you know how to tap it.
What Is Home Equity?
Home equity is the difference between the amount you owe on your home and its current value. For example, if you own a home worth $600,000 and owe $150,000 on your mortgage, your available home equity is $450,000. If you’ve paid off your mortgage, your home’s current value is your home equity.
Many seniors may not be familiar with using home equity as a retirement tool. But just as you can use home equity when you take a line of credit out against your house to remodel your kitchen or add a pool, you can also access that equity to help see you through your retirement years.
“Many people may feel like they have to sell their home and downsize when they retire to fund their retirement, but really what they want to do is stay and age in place,” says Khari Washington, a broker at 1st United Realty & Mortgage, Inc., in Riverside, Calif. “[Fortunately,] there are other financial options for people who are retiring.”
How Can You Access Home Equity?
According to a “Seniors’ Access to Home Equity” report published by the Urban Institute, about two-thirds of homeowners over 65 own their homes free and clear without a mortgage. And home equity has the potential to enhance a retiree’s financial security.
You won’t likely be able to access all your home equity at once, but that can be a good thing.
“Realize that some trapped equity is an important security blanket against unexpected out-of-pocket healthcare expenses,” says Laurence Kotlikoff, a Boston University economist and president of MaxiFi. His latest book, “Money Magic.”
Here are a few different ways to tap into home equity to fund retirement.
Home Equity Line of Credit (HELOC)
A home equity line of credit, commonly called HELOC, is a variable rate line of credit that stays open for a certain period. During this time window, you may withdraw money for significant expenditures or living expenses.
“HELOCs can be helpful because you can have a large limit but only use the amount you need so that you don’t have to pay interest on the entire credit limit, just the part you borrowed,” says Washington.
A HELOC has no closing costs, and rates can vary depending on your creditworthiness, current economic conditions, and the amount of equity in your home. You don’t have to repay any money on your HELOC during the draw period. If you do take money out, your line of credit will readjust to reflect the new amount.
“The downside of a HELOC is that they carry higher interest rates than traditional mortgages,” says Washington.
Home Equity Loan
A home equity loan, also known as a second mortgage, allows homeowners to tap into about 80-85% of their equity. Once you take the loan, which includes closing costs, and has a fixed interest rate, you get a lump sum amount that you must immediately begin paying back. Average interest rates will depend on your credit score, equity situation, and debt.
Most home equity loans have 10- or 15-year terms, meaning you will need to pay back the amount within that timeframe. If you’re using the money to improve your home or make it more accessible or comfortable for senior living, it may be helpful to aging in place.
A reverse mortgage allows you to borrow a certain amount of your home equity without making monthly mortgage payments. However, you must meet certain loan obligations such as maintaining the home and paying property taxes and homeowners insurance.
The Federal Housing Administration (FHA) insures most reverse mortgages. They include newer rules that borrowers have better safeguards against high-interest rates and extraneous fees and specific protections for a non-borrowing spouse.
The principal and interest will be due when the house is sold, the borrower or qualifying non-borrowing spouse dies, or the borrower fails to comply with the terms of the loan.
“A pro [in favor of] reverse mortgage is that you don’t have to pay taxes on the loan proceeds, says Washington.
It’s worth noting that you are still responsible for other taxes like property taxes. You must also pay for homeowner’s insurance and additional costs associated with the upkeep of the property outlined in the terms of the loan.
No matter what retirement looks like for you, it’s important to know that home equity can help with retirement. But you should consult a financial professional to determine what is right for you.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.