Is your Home an Investment?
Real estate is obviously an investment asset class. However
in addition to REIT’s is that limited to commercial or residential real estate.
You may like to think of your home as an investment that will appreciate
overtime. This, together with your decreasing mortgage can result in
significant equity available in retirement.
However as a Financial Planner I prefer to consider this
equity as a personal rather than investment asset. The primary purpose of this
equity is to fund future living situations whether such as your current home, a
new home, or a residential living facility. Then your investment assets,
pensions and other passive income streams fund your living expenses.
In most cases this works great. That untapped equity in the
home becomes an additional emergency buffer. This might reduce the need for
long term care insurance. Or if never
used becomes part of the estate to pass on to heirs.
However there are situations in which resources other than
home equity are insufficient. This may be by design in which people have put a
lot of money on their home. Or it may be an unplanned situation. In either case
this home equity becomes an important resource for a successful retirement
plan.
Home Equity and Retirement Planning
When using home equity in a retirement plan the standard
approach is to hold off using this equity until late in retirement. Most people
see that home equity as a safe haven (the 2008 crash notwithstanding) and so
would prefer not pull equity out of their home sooner. That equity may then be
utilized in a number of different ways. One approach is to move to a less
expensive home making any excess equity available. If staying in the home a
Reverse Mortgage is another approach.
Reverse Mortgage
A Reverse Mortgage is a loan only available to senior home
owners that uses a portion of your home equity as collateral. Funds can be
received in a lump sum, monthly, or as a line of credit. It is called ‘reverse’
because you do not make monthly payments and overtime the equity in your home
decreases based on the equity used and associated interest due. The loan
balance generally does not need to be repaid until the last surviving homeowner
moves or dies. The estate then has approximately 6 months to repay the balance.
The FHA offers a Home Equity Conversion Mortgage (HECM)
which is a reverse mortgage guaranteed by the Federal Government. These reverse
mortgages tend to have the lowest interest rates but have a maximum loan size.
With the exception of the offerings of some credit unions, private reverse
mortgages may have a higher limit and lower upfront and monthly fees but
typically charge a higher interest rate.
Reverse Mortgage and Retirement Planning
If we view home equity as just another investment asset we
might consider different priorities for when and how to use it in a retirement
plan. An article in the February Issue of the Journal for Financial Planning, "Reversing
the Conventional Wisdom: Using Home Equity to Supplement Retirement
Income," is a technical paper examining this issue.
Barry H. Sacks, J.D, Ph.D and Stephen R. Sacks, Ph.D did a 30 year comparison
of the use of a reverse mortgage
1) As a last resort
2) Used first, before the investment portfolio
3) With a a coordinated strategy using both investment portfolio assets and
a reverse mortgage home equity credit line.
They found that using the reverse mortgage
last had the poorest results. The coordinated strategy provides the highest
retirement plan confidence levels, and a higher net worth of the remaining
estate twice as often.
These findings make a lot of sense. Consider
substituting a CD for that home equity. By using the CD first we leave more of
the higher earning investment portfolio to grow over a longer period. However
it also seems that we have increased risk by using ‘safe’ assets first. As long
as there are a sufficient amount of other safe assets (i.e, emergency funds, a
cash allocation in the portfolio, etc), then using the ‘excess’ safe assets is
reasonable.
However many of my clients would have no
interest in pulling equity out of their home immediately upon retirement. Many
are still paying mortgages and have a goal of paying it off as quickly as
possible.
This leads to another clever use of the
reverse mortgage equity line of credit. Harold Evensky (Evensky & Katz
Wealth Management, www.evensky.com, ) has recently
proposed the use of this line of credit as a source of emergency funds. These
funds could be utilized for a sudden emergency need for cash. They could also
be used to live on instead of portfolio withdrawals in a year of negative
investment performance. The funds could then be repaid in good years, restoring
the original equity.
The reverse mortgage line of credit works
exactly like a regular Home Equity Line of Credit (HELOC), with the exception
that it does not result in a required stream of loan payments. The danger of
this open ended approach is that a person might erode their home equity over
time unnecessarily, without paying down the balance in the good times.
Conclusion
The Reverse Mortgage is another powerful tool in the
retirement income planning tool box. As with the other options available, it is
not always the best approach. It should only be used when it is appropriate for
an individual’s particular situation. There should be careful planning to
determine the most optimal timing and method.
