Many retirees have built up significant home equity over the years, but surprisingly, they often overlook it in their retirement planning. With the average home equity for homeowners in the U.S. sitting at around $300,000, it’s a valuable asset that can be leveraged to support retirement.
“You can do a couple of different things with your home equity,” says Pam Krueger, founder and CEO of Boston-based Wealthramp, an SEC-registered adviser matching platform. “It all comes down to picturing the funnel. It starts wide at the top, and then, as you start to learn there are costs and rules, the funnel gets skinnier.”
The 'how' of using home equity in retirement is straightforward — you can either cash out or borrow against it. The 'why' is a bit more complex. For some, tapping into home equity is a way to supplement retirement income, moreover protect and grow their nest egg. For others, it's a way to cover unexpected costs or fund a personal dream. But should you tap into your home equity in retirement? And if you do, what is the best way to go about it?
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Cashing out and boosting your income
If you’re worried about cash flow in retirement and are open to moving, selling your property and downsizing to a smaller, more affordable home could free up extra money for your retirement. However, this decision requires careful consideration. While a cheaper location might seem appealing, it’s important to assess whether it could lead to isolation or make transportation difficult.
“It could make sense to downsize and own a home free and clear, but you need to do the research,” says Denny Artache, president and CEO of Artache Financial Group, a financial planning firm in Jupiter, Fla. “You might own the home outright, but if the nearest supermarket is ten miles away, can you manage that?” Additionally, be cautious about choosing a property that could be hard to sell in the future or one that’s prone to natural disasters.
Beyond improving your cash flow, downsizing to a smaller home and owning it outright can also reduce the risk of running out of money in retirement, according to research from Morgan Stanley. The investment bank looked at a scenario where a retiree downsizes to a smaller home that she outright owns versus renting a comparable one. Then, if over time her savings become depleted and she needs income, she could sell the home and live in a rental. In this scenario, the likelihood of running out of money decreases significantly.
When deciding whether cashing out is the best move, you also need to consider tax implications. If you make a profit from selling your home, you won’t have to pay taxes on the first $250,000 in profit for single filers or $500,000 for married couples filing jointly. However, any profit above that is subject to capital gains taxes, which, depending on your income tax bracket, can range from 15% to 28%.
For example, if you purchased a home for $250,000 and sold it for $800,000, you’d have a $550,000 profit. Depending on your tax bracket, you could owe between $82,500 and $154,000 in taxes. The larger your equity, the bigger the tax burden.
“This is where it makes sense to sit down with a financial advisor and do a deep dive,” says Krueger.
Pay for long-term care
If you intend to stay in your home and require long-term care, a home equity line of credit or HELOC can be a way to pay for it. HELOCs have a lower interest rate than a personal loan or credit card and they are quick to obtain. With a HELOC you have a drawdown period, typically ten years, where you only pay the interest. After that you are on the hook for the interest and principle.
Currently the average rate on a HELOC is around 8.26% while the APR on a personal loan is 12.46% and 20.1% for a credit card, according to Bankrate. Keep in mind HELOCs have closing costs which typically range from 2% to 5% of your loan.
Weather market downturns
A HELOC can also be used as a way to weather market storms. If your retirement portfolio isn’t performing and it is a choice between selling stocks at depressed prices to support your income or taking out a HELOC, the latter may be the more cost effective choice. After all, stocks tend to rebound and then some.
Morgan Stanley points to the financial crisis in the early 2000s as a prime example. During that time, the S&P 500 lost more than half its value over a ten-month period. Three years after reaching the bottom of the selloff, the S&P recouped all its losses. Instead of selling stocks during those three years the retiree could have tapped the home equity and let their portfolio recover.
Market history had several similar eras, Morgan Stanley noted, in the late 1960s, early 1970s and early 1980s. "Our research shows that using home equity to support income during these periods mitigated the losses on retirement holdings and allowed retirees to ride through the turbulence, without significantly damaging their portfolios."
A HELOC, the bank noted, "can act as a financial cushion, allowing the investor to potentially avoid selling portfolio assets at fire-sale prices to provide income.”
In the pursuit of happiness
Downsizing can be more than moving to a cheaper home. It can also be an opportunity to pursue your dreams and potentially make money. Perhaps you dreamed of owning a jet ski rental in the Caribbean. Or maybe you want to dabble in the stock market with your newfound freedom. Some people who have a lot of home equity sell their homes, downsize drastically and use some of the proceeds to pursue their dreams.
Bottom line
There are many ways to leverage home equity in retirement. The right approach for you depends on your vision for your golden years. Whatever path you choose, it’s essential to do your research. After all, your home isn’t just where your heart lies — it can also be a tool to protect and grow your retirement nest egg, if used wisely.
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