Your Home Equity Release Options in Retirement
Ray Hoger, ARTA President
This article is based on a web post from boomerandecho.com, one of my favourite financial educational websites, written by Robb Engen, Qualified Associate Financial Planner (QAFP).
According to Robb Engen, many retirees want to stay in their homes and age in place as long as possible. The challenge is, assuming the home is paid off, that a large chunk of your personal equity is tied up in that home. How can you tap into that equity to help maintain an acceptable standard of living? Homeowners may be doing fine now, but what financial surprises potentially await?
There may be home renovations, a major travel destination calling your name, the need for a new vehicle purchase, or a desire to send extra cash to loved ones before we pass into that grand classroom in the sky. Here are a few options suggested in the post.
Reverse Mortgages
A reverse mortgage allows you to stay in your home and maintain a comfortable lifestyle. Typically, you are allowed to borrow up to fifty-five percent of the value of your home. The amount you are allowed to borrow will depend on the value and age of your home, as well as your age.
You can receive a lump sum, monthly, or quarterly payments (all tax-free). Lump sum payments start charging interest on the full amount right away, and so can be quite expensive. Interest charges are added to the amount borrowed and are recovered when the home is sold, or on the death of the last person named on the property deed. You must stay current with necessary home maintenance, pay your annual property taxes, and have homeowners’ insurance to cover the typical home perils.
You can receive a lump sum, monthly, or quarterly payments (all tax-free). Lump sum payments start charging interest on the full amount right away, and so can be quite expensive. Interest charges are added to the amount borrowed and are recovered when the home is sold, or on the death of the last person named on the property deed. You must stay current with necessary home maintenance, pay your annual property taxes, and have homeowners’ insurance to cover the typical home perils.
The challenges include the initial costs (legal, appraisal, setup fees, and closing costs). Interest rates are usually higher than a typical mortgage. Mortgage insurance premiums can be included in the costs. This insurance covers the lender in cases where the value of the loan is greater than the value of the home. There will be less money in your estate to leave for any heirs. In addition, the estate will have a limited time in which to repay the reverse mortgage. Most lenders allow between three to twelve months for the reverse mortgage repayment, while some estates can take over one year to settle.
Home Equity Lines of Credit (HELOC)
A HELOC is a credit tool (loan) that is secured by the equity in your home. You may borrow up to sixty-five percent of the value of your equity. Since your loan is secured by a significant real asset, your house, the interest rates are typically much less than a credit card or personal loan. At a minimum, you are required to pay the interest monthly, while some lenders may require payment of the interest plus a small percentage of the amount borrowed. A HELOC may be useful for a major renovation or to handle unexpected expenditures or loan consolidation.
Some potential challenges include a rapid increase in interest rates, which would escalate your monthly payments, a temptation to borrow more than you can afford to pay, and, worst of all, potential loss of your home if you can’t make the HELOC payments and are forced into selling your home to repay the loan. Keep in mind that if you only pay the interest monthly, you will always have the value of the loan outstanding, ensuring a regular contribution to your financial institutions profit line! Fees associated with this type of loan include legal, appraisal, title search, administrative and monthly costs. There are also discharge or cancellation fees when you cancel the HELOC.
Selling to Downsize into a Smaller Home
The idea is quite simple: sell the large family home, purchase something smaller, and invest the difference to add to your travel fund, save for later-in-life potential medical costs, or parcel out to adult children or grandchildren.
The challenges here are that after all selling and buying costs are considered, unless you are living in a very large newer home, the balance for investing can be relatively small. In addition, there is still much of your personal wealth tied up in a property, as well as maintenance costs, taxes, insurance, etc. to consider. The reduced space may also limit your entertainment options for friends and family, and your hobby room may disappear!
Selling to Move into a Rental
This option is seen by some financial bloggers and experts as the most reasonable option. It allows you to access the equity in your home, there is little to no maintenance, you have greater flexibility regarding location and length of stay in one location, and travel becomes much easier – just lock up and go!
This option is not without challenges. You can expect your rent to increase over time. Landlords can sometimes act in an arbitrary manner not in your favour, and they may delay maintenance responsibilities. Some rental facilities do not welcome pets, and decorating or modifying your rental space can be difficult or impossible.
Final Thoughts
There truly is no right or wrong answer – your financial situation will be a major consideration, as well as your personal preferences. Research the pros and cons of the various options. Speak to a fee only financial advisor if you are considering the HELOC or a reverse mortgage. The best decision is always an informed decision.
Ray Hoger is passionate about retirement finances — but don't take his word for it! Always consult a qualified financial professional before making any decisions regarding your financial future.