Home equity is the difference between the debt you owe on your home and the value of your home. According to the Survey of Consumer Finance, 50 percent of the net wealth for most U.S. households is in home equity.
With so much wealth tied to their homes, it is no wonder that seniors are turning to their home equity as a way to supplement their retirement finances. Nor should it be a surprise that there are many different products to help seniors tap their equity.
Reverse Mortgages, Home Equity Loans and Downsizing are all ways to get cash out of your home but each product works differently.
- Home Equity Loans are loans against the equity you have built in your home and it must be repaid.
- Downsizing is selling your home and buying a less expensive one.
- A Reverse Mortgage is a kind of loan that isn’t repaid until you leave your home.
Each of these products has disadvantages and advantages. The product you choose may depend on your cash needs, the value of your home, your age, your time horizon and other factors. Continue reading for a summary of the pros and cons of each product.
Summary of Pros and Cons of Downsizing
Downsizing is selling your existing home and moving to a less expensive residence. Downsizing may involve moving to a smaller home, a less expensive community or both. The details are more complex, but a simple scenario illustrates how you could sell your $500,000 home and buy a less expensive residence for $350,000 – giving you an additional $150,000 for retirement expenses. (Minus broker and moving fees. Plus reduced maintenance costs.)
You can learn more about Downsizing or Relocation, but this is a summary of the pros and cons:
Advantages of Downsizing
- Downsizing generates efficient cash out of all the equity you have accumulated to date – without additional interest to be paid or debt. Downsizing is widely considered the most efficient way to get money out of your home.
- Downsizing represents an opportunity to potentially eliminate or reduce mortgage debt.
- Many seniors find that a smaller residence or a home in a community more suited to senior living is much better suited to them than their traditional home.
- Maintenance costs will be lowered with a less expensive residence.
- There may be significant tax advantages to downsizing.
- The equity in the smaller residence can still be tapped with a Reverse Mortgage or other product.
Disadvantages of Downsizing
- Emotional attachment to family home and community. Many seniors wish to stay where they have always lived.
- There are significant costs – both real and emotional – involved with selling a home and moving.
Summary of Pros and Cons of Reverse Mortgages
A Reverse Mortgage is a special kind of loan – available to seniors ages 62 and above. What makes a Reverse Mortgage different from a home equity loan is that you do not pay the money back until you die, sell or permanently move out of your home. Depending on many different factors, a 70 year old homeowner of a home valued at $500,000 (with no existing mortgage) could receive as much as $250,000 in cash. This sum would be repaid when the house is sold, and the amount owed will never exceed the value of the house.
Continue here to learn more about Reverse Mortgages, or evaluate this summary of the pros and cons:
Advantages of Reverse Mortgages
- You get to stay in your home and retain ownership of the property.
- Substantial equity can be taken out, depending on your age, home value and current interest rates.
- The interest rates tend to be lower than those on forward mortgages or home equity loans.
- There are potential tax benefits to a Reverse Mortgage.
- There are no payments while you are living in the home.
- While interest accumulates, it is not due until you leave or sell the home.
- You will never owe more than the value of the home.
Disadvantages of Reverse Mortgages
- Interest accumulates on amount you borrow. (Though you will never owe more than the value of your home.)
- Upfront costs on a Reverse Mortgage are considered high, higher than mortgage refinancing.
- The interest ultimately paid on the loan amount may be higher than that charged in a Home Equity Loan
- The homeowner must continue to pay the costs of home maintenance, such as property taxes and homeowners’ insurance.
- The product is complex, and requires the homeowner to undergo counseling to ensure that they understand it.
Summary of Pros and Cons of Home Equity Loans
Research shows that Home Equity Loans – specifically Home Equity Lines of Credit (HELOC) and Cash Out Refinancing – are currently the most popular choice for retirees seeking to get cash out of their homes. A Home Equity Loan enables homeowners to borrow money that is secured by the equity they have in their home. The borrower pays interest and pays down the loan as soon as the money is borrowed.
Typically, homeowners are allowed to borrow up to about 80 percent of their equity. However, the amount actually available to you will vary greatly depending on your monthly income and credit rating. If you have a $500,000 home with no outstanding mortgage, you could get access to funds up to $400,000. (However, it is very important to note that most borrowers do not have the income requirements necessary to access this much money. A more typical scenario might mean borrowing $50,000 to $100,000.)
There is more information about Home Equity Loans in the Mortgage Refinancing section, or evaluate the following summary of pros and cons:
Advantages of Home Equity Loans
- You can stay in your home.
- You can still benefit from the appreciation of your home’s value.
- You may be able to deduct the interest paid on the mortgage from your taxes.
- HELOC transaction/closing costs can be very low.
- A HELOC also offers flexibility in timing the drawdown of your loan amount.
Disadvantages of Home Equity Loans
- Not everyone is eligible for Home Equity Loans since there are income and credit rating requirements for repaying the additional debt
- The homeowner must continue to pay the costs of home maintenance such as property taxes and homeowners’ insurance.
- Once the Home Equity loan is tapped, there are regular payments to be made, increasing the potential risk of foreclosure.
- Borrowers must be careful not to borrow more than the ultimate value of their home. This can be tricky to estimate in a stagnant or declining housing market.
As illustrated above, there are many ways to access your home equity. These products should each be evaluated with respect to your income, asset and expense needs as well as with careful consideration to your time horizon. The overall health of the housing market and fluctuations in interest rates should also be factored into your decision. Choosing the right product for you can be difficult. You may wish to consult with a professional Retirement Financial Planner.