Retirement Planning: How to use Home Equity to Insure Your Retirement

We all worry about money and our financial future.  And if you are approaching retirement, then your concerns are probably heightened. In today’s financial environment, few things are sure. In retirement, you require your existing assets to be stable and predictable, since you are not making money from work (or making less from work).
For both emotional and financial security: think of your home as part of your retirement plan.
For both emotional and financial security: think of your home and home equity as a vital part of your retirement plan.
However, your retirement assets are usually partly invested in the financial markets.  And these markets can be wild and not at all predictable.  For example:

  • The stock market is never a sure bet in the short term.  Recent fluctuations are not as severe as the stock market drops in 2008 and 2001, but many market observers feel that we are due for a correction.
  • While housing prices have recovered in the past few years, some analysts are forecasting a 15% drop in home prices which would have an even bigger impact on home equity.
  • The Fed has recently indicated that they may raise interest rates, which could cause a drop in the stock market. Home prices could also be impacted.  And, inflation could become a factor.

As a retiree, you want to see some positive returns on your investments, but you also need to shield yourself from risk and insure that your basic needs are covered.

If you are a homeowner, here is some good news: home equity can likely be used to reduce risk in your overall retirement plan – somewhat like insurance.

Including Your Home Equity as a Vital Retirement Asset

For homeowners, one strategy for balancing your need for both predictability and risk is to include your home equity as a vital part of your overall retirement assets.

When most people think about their retirement assets and income – they think: savings, investments, Social Security, annuities, and pensions (if you are lucky).  However, your home equity is probably your most valuable asset but one that many people are overlooking even though there are numerous ways to use that equity to strengthen your overall financial profile.

All financial experts talk about diversification and the value of real estate as an investment but not enough people think about their home equity as a vital and useful part of their retirement portfolios.    Recently Boston College’s Center for Retirement research put out a booklet on how to use Home Equity to generate Retirement Income.

Here are four ways to rethink your home equity and use it as a powerful tool for your retirement plan.

1. Lock in Your Home Equity and Hedge Interest Rates

A group of financial planners and wealth advisors have just released a new report in the Journal of Financial Planning outlining the benefits of taking out a federally-insured home equity conversion mortgage (HECM — also known as a reverse mortgage) at a time when interest rates remain at historic lows, rather than waiting and risking the possibility of rates increasing or exhausting your retirement portfolio.

Whether someone qualifies for a HECM is based on 3 factors:

  • Their age – you need to be over 62 and the older you are the more you can qualify for
  • The amount of equity someone has in their home – generally you need at least 50% equity
  • Prevailing interest rates – as rates rise the amount of equity needed to qualify rises

If interest rates jump up then people who qualify today may not longer qualify for two reasons – rising rates may depress home prices and lessen your home equity  (it become more expensive for new buyers to get mortgages) and higher rates mean lower proceeds from the HECM.

If you get a HECM when rates are low and home prices are high then you are locking in your current home equity.  If you get a line of credit and don’t draw it down, then your borrowing costs shouldn’t be too high since you only pay interest on the outstanding debt.

2. In a Down Stock Market, Tap Equity Instead of Savings

In addition to hedging interest rates, the studies show that the reverse mortgage line of credit is a useful source of funds to be drawn down at times when other investments are suffering.

Say your stock portfolio has lost value in the short term. Rather than selling stock at a loss in a down market, you can draw down on the line of credit and then can repay it later for future use.  You can use the line of credit as a bridge loan while wait for your investments hopefully regain value before selling them.

These changes were considered in the financial experts’ latest report; some of the same researchers have previously explored using a “standby” reverse mortgage line of credit as a strategy to preserve and extend retirement portfolios.

“Early establishment of an HECM line of credit in the current low interest rate environment is shown to consistently provide higher 30-year survival rates than those shown for the last resort strategies,” found researchers Shaun Pfeiffer, Ph.D.; C. Angus Schaal, CFP®; and John Salter, Ph.D., CFP®, AIFA®.

In other words, using the HECM line of credit in conjunction with managing an investment portfolio resulted in the investment portfolio lasting for at least 30 years much more of the time.

For the study, researchers projected several outcomes for a sample HECM line-of-credit borrower in California with a $500,000 nest egg and $250,000 in home equity at time of retirement. The nest egg comprised a portfolio split 60/40 between stock and bond investments along with a six-month cash reserve. The simulation used a 4-6% withdrawal rate of the credit line in 1% increments.

3. Grow and Protect Your Home Equity in a Predictable Way

A reverse mortgage line of credit has an important feature that makes it very appealing to financial planners: it grows no matter what happens to housing prices.

The unused portion of the line of credit grows over time, increasing the amount borrowers can access as they age.  Thus, taking the reverse mortgage line of credit early and utilizing the guaranteed growth feature can be less risky than waiting, since if interest rates go up or housing prices drop the homeowner may no longer qualify.

Additionally the current HECM line of credit growth rate is currently ~ 3.4 – 3.8% annually, so borrowers are locking into this growth rate for as long as the the HECM is in place.

4. Just Wait and Tap the Equity if You Need it as You Age

This is the default approach for most retirees today for a number of reasons, including:

  • the features of a HECM are not widely understood and there are a lot of mis-conceptions about the product
  • people feel an obligation to “save” their home equity for future generations
  • people feel that using home equity is a last resort – even though the research shows that making it part of an integrated plan is actually less risky

The problem with this approach is that you may be better off using it in tandem with your other assets and depending on home prices and interest rates the opportunity to leverage home equity may decrease or go away in the future.

The good news is that financial planners, researchers and consumers are thinking carefully about how to make use of all the assets someone has to maximize quality of life in retirement.

While each borrower’s situation is different, the research findings suggest that leveraging home equity sooner rather than later may be helpful for a number of retirees.

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