May 10, 2019
How to Use Your Home Equity in Your Retirement Plan
If you have equity in your home, it’s sensible to think about the role it can play in your retirement plan. Ideally, your savings and investments should be enough to fund your expected retirement needs. But should there be a setback or market shift, tapping into your home equity can provide the cash cushion you
There are three options if you want to tap into the equity you have in your home. You can borrow against your home using a line of credit (HELOC) or you could take out a reverse mortgage. The third option is to sell your house entirely and move somewhere less expensive. Each of these routes carries its trade-offs, both financially and emotionally. It’s a personal decision that requires thought and preparation. This is where having a financial plan can help.
Option 1: Borrow against your home
If you’re in need of a cash cushion and have equity built up, a home equity loan or home equity line of credit, also known as a HELOC, could be the right tool.
A home equity loan works like any other, with a twist. You’ll have a set amount of money to be paid back with interest and instalments each month. They can be slightly easier to qualify for that unsecured debt, but that’s because you are borrowing against your home’s value to secure the loan. Be aware of this fact when looking at a HELOC, as you may be uncomfortable with the idea of using their home to secure debt.
A HELOC resembles a second mortgage on your home but operates like a credit card. Just remember the amount you get is based on how much equity you have in your home, and can allow homeowners to access up to 65 % of those funds.
In contrast to a home equity loan, HELOC funds can be withdrawn whenever you need the money, rather than taken in a lump sum. However, you cannot exceed the amount set when you signed for the line of credit, much like a standard credit limit. It’s also vital to remember that HELOCs are using your home as collateral, and are designed for people who have sufficient income to pay at minimum, the interest each month.
If you’re planning to apply for a HELOC, it’s much easier to do so pre-retirement. Your income level and credit score will be used to determine the lending decision. Therefore qualifying can be problematic if you’re already living on a retirement salary, assuming it’s lower than your income pre-retirement.
Option 2: Take out a reverse mortgage
A reverse mortgage is precisely that – the reverse of a traditional mortgage. Instead of you paying your mortgage lender money and growing equity in your home, the lender pays you, taking up to 55% of the equity out of your home. This allows you to turn your equity into monthly income while remaining in your home.
A reverse mortgage generally comes with a rate of interest several percentage points higher than an average mortgage. This interest will eat into your equity. However, the attractive side to a reverse mortgage is that no payments are required on the debt until the house is sold or you pass away.
Overall, a reverse mortgage is the least recommended route and should only be considered if you’ve exhausted all other options. Over time, your total equity decreases and your debt increases as interest continues to compound.
Option 3: Downsizing your home
The most straightforward way to access the equity you have in your home is to sell it and downsize.
While you may want to stay in your family home as long as possible, built-up equity could provide the cash you need. Once you sell, the money is yours to use for retirement, living expenses, or other cash needs. As a bonus, liquidating all or a portion of home equity will bring additional cash flow to be able to invest the equity, you just freed up as well.
Further, in many jurisdictions you don’t pay capital gains tax on your primary residence, so the gains you make on your home would be tax-free (check local laws to be sure).
However, it’s important to note that before moving to a smaller house or apartment, you should think about both the lifestyle and financial aspects. Bluntly: if you planned a gracious country retirement, a small apartment in the city may not feel good even if you have additional cash on hand.
Think about things like how you want to spend your time or the potential psychological effects of downsizing.
Further, consider your specific financial goals while also thinking about how and where you want to live in retirement. This will give you a better idea of whether or not selling your house is a good step for you to take. It’s also important to see how downsizing fits into your overall financial plan. Planswell can help you get on track to have a clear vision of your priorities in retirement, and help you assess your options.
So… should you depend on your home equity?
When it comes to making the final decision of factoring your home’s equity into your retirement plan, it truly runs on a case by case basis. Following the adage of never putting all your eggs in one basket, you should run down your financial savings before tapping into your home equity. All of that starts with a financial plan, which Planswell can help you with to ensure you’re financially stable for years to come.