How to Unlock the Value of Your Home

Many retirees and soon-to-be retirees are house-rich but cash-poor. Their mortgages are mostly or fully paid off, and their houses have climbed in value since they bought them, creating thousands and thousands of dollars in equity—yet their other savings are too limited for them to enjoy the retirement they want…if they can retire at all.

There are three common approaches to unlocking the value of your home—downsizing…obtaining a reverse mortgage…or using a home-equity line of credit (see below). There are advantages and disadvantages to each…

Downsizing

You could sell your home and then ­either rent or buy less expensive housing. This may not be an attractive option for people who hoped to continue living in the homes they are used to. But financially it often is the best choice.

That’s because downsizing not only frees up assets—it can dramatically reduce ongoing expenses. Nationally, property taxes, utilities, maintenance, insurance and the like tend to total ­approximately 3.25% of a home’s value each year—so downsizing can produce big savings.

Example: Downsize from a $400,000 home to a $200,000 home, and you not only free up $200,000 for your retirement, you also are likely to save around $6,500 a year in ongoing housing costs, which would add up to $130,000 over a 20-year retirement. You might save even more by choosing a new home that is especially energy-efficient and/or in a town with low property taxes.

People in or near retirement often can downsize without any significant decrease in quality of life because their existing homes are not well-suited to their current needs. Their kids generally have moved out, so they no longer need a large home or one in an area with great (and high-tax) public schools. And once home owners retire, they no longer need to live close to employers. Moving might mean being farther away from friends—but keep in mind that as your friends age, they, too, may choose to move.

Downside: Selling a home is expensive. Broker fees, moving costs and the cost of fixing up your current property before putting it on the market could add up to 10% of the property’s value.

Selling your home could trigger capital gains tax, though this is not common. Married people who file jointly (and people widowed within two years of the home sale) generally will not have to pay taxes on the sale of a primary residence as long as their profit on the sale does not exceed $500,000 (the limit is $250,000 for single filers). A couple who bought a home for $250,000 and spent $50,000 improving it over the years could sell it for as much as $800,000 without triggering taxes, for example. See IRS Publication 523, Selling Your Home, for details.

Downsizing could come back to bite you if you or your spouse later require an extended nursing home stay. This care can cost upward of $80,000 a year, and Medicaid will not start paying these bills until you have exhausted virtually all of your assets. In most states, the primary residence can be excluded from ­Medicaid’s eligibility calculations, potentially allowing a spouse or heirs to hang onto this asset—but if you downsize and pocket the profit, that profit would be at risk.

There are limits and restrictions that can complicate Medicaid’s primary residence exclusion. For more details, visit LongTermCare.gov and select the “Medicare, Medicaid & More” link on the left…or enter your state’s name and “Medicaid” into a search engine to find contact information for the agency that manages your state’s Medicaid program.

Bottom line: Because of its potential to greatly reduce ongoing expenses, downsizing is the first option to consider if you want to free up equity from your home. If you think you are likely to downsize at any point during your retirement, do so as soon as possible to maximize these savings. Yes, there are steep costs involved in selling a home, but those costs will have to be paid at some point, either by you or your heirs. There are emotional reasons to not downsize, but financially, downsizing tends to be a bad choice only in very exceptional circumstances—for example, if you or your spouse has a ­degenerative health condition that makes a Medicaid-financed extended stay in a nursing home likely.

What about renting rather than buying? If you are 70 or younger and downsizing, buying has an advantage—it protects you against the possibility that rents could rise sharply in the future. If you are 80 or older, renting is preferable because there’s a good chance that you won’t be able to live independently long enough to justify the transaction costs generated by buying and later selling a new home. If you are in your 70s, a case could be made for either renting or buying, depending on your preference and what’s available in your new location.

A Reverse Mortgage

If you are 62 or older and own your home outright (or have a relatively low mortgage balance), you likely can qualify for a reverse mortgage. This is a type of loan that lets you borrow against the equity in the home with no loan payments required during your lifetime as long as you continue to live in the home. The amount that you can borrow depends on the value of your home and your age, among other factors—the older you are, the more money you can get, all else being equal. This money can be received as a lump sum, a line of credit or monthly payments.

Example: A 65-year-old with $250,000 in equity in his/her home could obtain a $127,000 lump sum…while a 75-year-old with a similar property could get a $139,000 lump sum.

Reverse mortgages have earned a bad reputation because of high costs, misleading advertisements and confusing contracts. One major complaint was recently eliminated. In the past, if only one spouse in a couple took out a reverse mortgage because the other was not yet 62 and thus not eligible, that younger spouse could later be forced out of the home when the borrower died or moved into a nursing home. Recent reforms allow the younger spouse to remain in the home.

The proceeds from a reverse mortgage are not subject to income tax or capital gains tax, and they typically will not affect your Social Security or Medicare benefits.

Downsides: Reverse mortgages are expensive. Example: For a $100,000 loan, up-front costs may be $8,000. To find a calculator that shows maximum allowed charges, go to ReverseMortgage.org/About/Reverse-Mortgage-Calculator.

Because reverse mortgages typically are repaid through the sale of the property after the borrower’s death, heirs usually will not be able to inherit the home, and there could be little or no equity left as a bequest.

Bottom line: A reverse mortgage lets you access your equity and remain in your home for the rest of your life. But you’ll pay steep up-front costs, which can be paid out of the proceeds of the loan, and funds withdrawn are charged a relatively high interest rate. So if you do not remain in your home for the rest of your life, these costs will significantly reduce the equity you’ll get when you move.

Be realistic—are you sure you will want to continue to live here even as your friends retire to other areas and your health and mobility decline?

Consider speaking with a fee-only financial planner before signing reverse mortgage documents.

When to Use a HELOC

Home-equity lines of credit (HELOCs) are an easy and inexpensive way to tap home equity—they have low up-front costs and reasonable interest rates. But they are not a good option for retirees who wish to use their homes to supplement their retirement income. Borrowers typically make only interest payments at first but must start repaying the principal as soon as the “draw period” ends. (The “draw ­period” is a predetermined time, often 10 years, during which the line of credit can be tapped.)

Other HELOC drawbacks include the fact that these loans almost always have a variable interest rate, so your cost of borrowing could increase even after you obtain the line of credit…and lenders sometimes have the option of canceling HELOCs at any time. They don’t commonly do so, but it means there is a chance that the cash you were counting on might not be there when you need it.

Still, a HELOC’s low costs and flexibility make it a great option if you are seeking financial flexibility to pay for occasional expenses such as when your home suddenly needs a new furnace.

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