Should you use your home equity for retirement income?

Older Americans tend to have more home equity than retirement savings and other financial assets, according to a recent report from the Boston College Center for Retirement Research (CRR). That means people approaching retirement with modest retirement savings and substantial home equity may want to consider the best use of their most valuable asset.

The CRR report does an excellent job of explaining in simple terms the different uses of home equity in retirement and the pros and cons of each approach. Currently, the most common use is for retirees to live in their current home rent-free, with no landlord who could raise the rent or ask you to move. In this situation, home equity is available as a reserve in case you incur costs for high out-of-pocket medical expenses or long-term care expenses in your later years (this latter cost is not covered by Medicare and most medical insurance policies). Unless home equity is tapped for these purposes, it becomes a legacy for children or charities.

In this scenario, you wouldn't use home equity to increase your retirement income or reduce your living expenses. This is still a good, classic approach to using home equity that deserves your consideration. One common challenge, however, is that some people stay in their current homes until they become frail and incur significant long-term care expenses. At that time, they may have limited financial resources and options, and their backs could be against the wall, meaning that they could be forced to sell their home quickly at a low price or incur high moving costs.

The CRR report contrasts two other ways of using your home equity to improve your day-to-day finances in retirement:

  • You could downsize to a smaller, less-expensive home, freeing up home equity and hopefully decreasing your housing costs, such as home insurance, utilities, repairs and property taxes. In this case, the amount of home equity not needed to cover housing costs could then be used to generate retirement income through investments or annuities. A variation is to use the home equity to reduce or eliminate your monthly mortgage payment for the new home.
  • You could take out a reverse mortgage, which would allow you to stay in your current home. In this instance, you'd receive either a lump sum payment or a stream of monthly income for the rest of your life. If you took the lump sum, you could invest it to generate retirement income, pay off your mortgage, or improve your home to make it more livable in your later years. Reverse mortgages are best for those people who want to stay in their current home for the rest of their lives.

The CRR report includes a numerical example that shows how each approach could improve your day-to-day finances and illustrates how you can determine if these approaches might work for you. It also explains important features of reverse mortgages and identifies helpful resources.

Here are two other potential uses of your home in retirement not included in the CRR report:

  • You could rent one or two rooms to realize some additional income. This could also help with loneliness, a critical risk for some retirees. For example, a single woman could piece together a "Golden Girls" retirement solution.
  • You could obtain a reverse mortgage line of credit and use it to develop a coordinated approach to drawing down invested retirement savings. Under this approach, you would invest your retirement savings and use systematic withdrawals to generate retirement income. When the stock market's down, you could draw on your reverse mortgage line of credit to meet your living expenses and suspend your withdrawals from invested assets. This would allow your savings to remain invested until the market recovers. Withdrawing from retirement savings during a down market is a significant risk with systematic withdrawals, and this strategy addresses this challenge. (If you decide to take this route, you may want to work with a financial planner who's familiar with this strategy, since it's somewhat complex.)

Clearly there's no one-size-fits-all solution to the best use of your home equity in retirement. The above strategies primarily consider the financial aspects, but for many people, there are strong emotional and psychological attachments to their homes that should be considered as well.

The best time to investigate your options is when you're approaching retirement or early in your retirement years. As you get older, it becomes harder to move out of your current home and implement these strategies.

Many baby boomers in particular face significant retirement challenges, and it's only common sense to creatively consider all your resources and options to help you create the retirement you want.

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    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.