Unlike earlier generations of retirees, who paid off first mortgages and retired at the family homestead, some of today's baby boomers are looking to capitalize on home equity to enhance their retirement savings. Popular strategies for tapping home equity include downsizing to a smaller house or condominium, relocating to an area where the cost of living is more affordable, and taking out a reverse mortgage.
Regardless of which strategy you choose, it's important to be realistic about what your house may be worth when you retire. Home equity may add value to a diversified portfolio, but relying too much on your house to fund your retirement could work against you if the real estate market in your area cools.
Making a Move
Selling your existing home and relocating to a more affordable house or condominium may be a reasonable option if you have considerable home equity and the shift won't negatively affect your lifestyle. As part of your research, remember to investigate the overall housing costs in your desired area. For example, real estate values and property taxes typically vary considerably by locale, sometimes even within the same state. Additionally, before relocating to a new area, you might want to spend significant time there to make sure it is compatible with your lifestyle and interests.
When calculating your home's sale price as part of the retirement income equation, be sure to use realistic assumptions. Real estate prices can be volatile, and it can be difficult to determine whether prices may level off, rise, or decline in the future. When planning your retirement income, remember the importance of diversification -- owning a portfolio of stocks, bonds, and cash investments in addition to home equity -- to help guard against market swings in any one area, including real estate. Of course, there are no guarantees that a diversified portfolio will protect against overall financial losses, but a diversified portfolio can position you to potentially take advantage of gains in several financial sectors.
Finally, when selling your home, consider that the first $250,000 in capital gains ($500,000 if you sell jointly with a spouse) is not subject to federal taxation if you lived in the house for at least two of the past five years.
A Reverse Mortgage: A Tool for Staying Put
Tapping home equity doesn't necessarily require relocating. A reverse mortgage may be a solution if you have significant home equity and a desire to stay in your existing home. With a reverse mortgage, you receive a source of income by borrowing against your home's equity. Payouts are tax free and may be taken as a lump sum, a line of credit, or an annuity-like payment schedule.
To qualify, you and other owners (such as a spouse or partner) must be at least 62 years of age. You must own your home outright or be able to retire an existing mortgage with the money you receive from the reverse mortgage. As long as the reverse mortgage is in effect, you are responsible for maintaining your home, and for paying taxes and insurance. The loan plus accrued interest is due when you die or sell the house.
When evaluating a reverse mortgage, be sure to consider the fees, which may be substantial. You may have to pay a loan origination fee of between 6% and 8% of the value of your home, in addition to servicing fees assessed over the term of the mortgage. Because of the relatively high fees, many experts recommend a reverse mortgage only if you plan to remain in your home for the long term. Also keep in mind that the amount you owe tends to grow over time, as interest (which is usually based on a variable, rather than fixed, rate) accrues on amounts that are gradually paid out. Over time, a reverse mortgage can completely exhaust the value of your home, leaving little if any assets left over for your heirs.
Study payout options associated with a reverse mortgage carefully to determine whether one may work for you.
You receive a considerable sum.
Interest accrues on the entire amount.
Line of credit
You have the flexibility to draw only as much as you need.
Fees may outweigh the benefit if you draw only a small amount.
You may receive a source of income for as long as you remain in your home.
Payments are not indexed to inflation.
The most recent downturn in the national housing market may have caused many baby boomers to question whether their home equity will be enough to see them through a comfortable retirement. If you're among those who intend to rely on a home's value -- either through downsizing, relocating, or obtaining a reverse mortgage -- make sure that your plans include realistic projections. And remember that maintaining a diversified portfolio of other types of investments can potentially help balance out your overall pool of financial assets.
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