Planning Your Retirement? Don't Forget About Home Equity

Historically, financial advice has treated homes as a source of wealth. When you buy a house – common wisdom holds – you treat it as a financial asset that can accrue value and contribute to your retirement plan.

But in reality, there are many problems with this advice. Home prices are slippery and unreliable, and maintaining a house over the years is very expensive. More importantly, your home is what economists call a "nondiscretionary asset." In layman's terms, you will always need a place to live. Even if you do sell the house, you'll need to turn around and spend much of the proceeds putting another roof over your head.

But while your house is not necessarily an investment, Morningstar recently published some advice for homeowners who want to include their house in their retirement planning. Compare your personal circumstances to the two classic ways of getting value out of your home to figure out if either is a good option for your retirement.

A financial advisor can help you reach your retirement goals. Talk to a financial advisor today.

1. Selling and Moving

• Advantage: Potentially generates up-front cash with no debt or ties

• Current challenges: High interest rates make it more difficult to find buyers, and may also complicate your own search for a new home

The classic option for getting value from your home is to sell it. Setting aside the very real emotional and personal issues involved, there are two major challenges here: You need to find a buyer, and you need a place to live.

This is more complicated than it seems. Selling your house is expensive. Staging, lawyers, realtors and more all cost money. According to Zillow, just paying the agents and lawyers involved can cost between 8% and 10% of the home's overall value. On average, they found, sellers spend another 3% of the home's value on marketing and $6,000 on cleaning, improvements and upgrades.

All of this comes in the context of high interest rates which, by design, deter buyers and lower offers.

A financial advisor can help you project your financial path to weigh your options.

What Does Selling Mean for Retirees? 

Ultimately, it means that selling and moving is probably a good option for people who are looking to significantly change their circumstances. If you want to move into a much smaller home or a rental property, selling might make sense. Similarly, if you need to move into a long-term care facility, home equity can be an excellent way to fund that transition.

Beyond that, though, it's likely that selling your home for real equity will be difficult. Getting into a new home may be more expensive than you anticipate, and high interest rates will also depress your asking price, reducing your total gains.

Reverse Mortgages

• Advantage: You can get value without having to sell or move

• Current challenges: Interest, fees and risk of foreclosure

If you don't want to sell, you can always borrow.

The second mainstream way to get money out of your home in retirement is to borrow against the property through a process called a "home equity conversion mortgage," more commonly known as a reverse mortgage. This tends to be a better option than something like a home equity loan, because you receive the money without needing to pay it back in retirement. Instead, you repay the loan either if you sell the house or through your estate when you die.

These products are… tricky. As Morningstar writes, "[r]everse loans can be difficult to understand, and they do come with high fees and some risks that have generated a lot of deserved bad press over the years."

"The big risk is foreclosures: Reverse loans do not require monthly repayments, but borrowers can default if they fail to make property tax and insurance payments or keep their homes in good repair."

Many people don't understand that last clause when they take out a reverse mortgage, and it's a popular tool for fraud. Bad actors will convince seniors to take out a reverse mortgage, then use outsized or unrealistic claims of repair issues to justify seizing the house. Given that seniors who take a reverse mortgage are, often, financially struggling to begin with, they may lack the resources to challenge an unexpected eviction.

To make a plan for retirement, talk to a financial advisor today.

But, if properly arranged and supervised by a qualified attorney, a reverse mortgage can be a valuable way to tap into your home equity without selling. It provides cash based on the value of the house and, since this is a loan to be repaid by the underlying value of the property, you don't pay taxes on the money you receive. That said, it's important to remember that this will affect any estate plans you can make, since the bank will get first claim against the home and your estate to repay the loan.

And high interest rates may hurt the amount equity you can take from your home, and make it more expensive to borrow. This is better done in a low interest-rate environment.

Home Equity Tips

• What exactly is home equity? This term is thrown around a lot in financial and retirement circles, so let's take a look at what it means. 

• A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

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