Don't ignore home equity when planning your retirement

Many older Americans are home-rich and cash-poor, and could use their home equity to help fund their retirement, according to a recent report on Americans' retirement challenges from the BiPartisan Policy Center (BPC). Financially strapped Americans in this situation may be making a mistake by not considering prudent uses for their home equity.

According to the BPC, Americans of all ages have more than $12.5 trillion in home equity, almost equal to the $14 trillion that Americans hold in retirement savings.

While this retirement funding source might be useful for all people, the case for using home equity is even more compelling for older Americans. The BPC reports that among families with assets headed by an individual aged 75 or older, their median financial assets are $29,000, while their median net worth including home equity is around $217,000.

Many Americans make the mistake of taking out home-equity loans while working for immediate consumption purposes. Such loans can deplete the value of the equity that they could tap in retirement. The BPC report encourages people to preserve their home equity to improve their financial security in retirement, particularly for workers who've saved little while working.

Reverse mortgages, which are loans against home equity that aren't repaid until the owner dies, moves away or sells the home, are a potential option. The loan balance accumulates with interest on the loan proceeds, and the balance is deducted from the net proceeds of the house when it's eventually sold. The proceeds can be paid in a lump sum or in periodic monthly payments, or a combination of the two. There are many details on reverse mortgages that people should understand if they're considering using them to enhance their retirement.

There are several ways that reverse mortgages can be used to help secure retirement, according to popular retirement researcher Dr. Wade Pfau:

  • Elect a monthly payment for life, similar to an annuity.
  • Receive a monthly payment for a fixed term, to enable a retiree to delay starting Social Security income, a smart financial move for many retirees.
  • Take a lump sum payment to retire other debt, such as an existing conventional mortgage, thus reducing your monthly living expenses.
  • Elect a reverse mortgage line of credit that's only tapped if your retirement savings are depleted.
  • Use invested assets to cover your regular monthly living expenses, and only tap your reverse mortgage to cover monthly living expenses when your retirement savings are depressed due to a stock market decline. This buys time for your retirement savings to recover from hopefully temporary stock market drops. This addresses the so-called "sequence of returns" risk with using invested assets to generate retirement income.

If you have sufficient home equity, you might be able to use more than one of the above strategies.

Of course, there are other ways to use home equity in retirement. You can:

  • Sell your home and downsize to a less expensive house.
  • Pay off your mortgage and enjoy living rent-free in your home.
  • Rent a room or two for extra income.
  • Reserve home equity as a resource you can tap in the future if you have high long-term care costs.

In this last case, you might investigate taking out a reverse mortgage line of credit now to lock in a current low interest rate, and not tap the loan until you really need it.

As you can see, there are many creative ways you might use your home equity for retirement income. It's simply common sense to carefully consider how to deploy all the retirement assets you own.

  • Steve Vernon On Twitter»

    View all articles by Steve Vernon on CBS MoneyWatch»
    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.