Retirees who own their homes outright are often at an advantage over their renting — and retired — counterparts. There are two reasons for this: their housing costs are generally lower and they have access to safety-net cash in the form of home equity.
However, all homeownership is not created equal, explains Russ Thornton, financial advisor at Wealth Care for Women in Atlanta. For example, if you move often, owning a home outright by age 62 can be challenging. For most people, a 30-year mortgage is the norm. If you plan to retire by 65, then you would have to buy a home by 35 and stay in it to retire mortgage-free.
“Those who keep their homes for years and years and years tend to grow equity, which can be a wealth builder,” says Thornton. “If there’s a reasonably high likelihood that you’re going to stay in the same home for 10 years or more, then you should probably buy. If you move every few years into more expensive houses then you might not get the same benefits from homeownership as those who stay in one place.”
Devising a long-term plan, including what homeownership looks like in retirement, is important, Thornton says. Since the big goal for retirement is to eliminate as many expenses as possible, erasing a monthly housing payment is optimal. In essence, renters who plan on staying in the same general area for years to come should consider buying.
1. They can say goodbye to mortgage payments
The twin bridesmaids of finances are income and expenses. When people retire, the money coming in usually shrinks, which means so should the money going out. A mortgage payment is one expense soon-to-be retirees should try to retire before they do.
“If you can be mortgage-free by the time you reach retirement, you’ll be in a good position. Retirees need to reduce their cost of living and owning a home is a good way to do that,” Thornton says.
Mortgage-free retirees can save hundreds or thousands of dollars each month. Even with property insurance, which costs an average of $93 per month, and taxes, the cost of owning a home is often less than renting.
Not only can retirees save on their housing costs, they can also make money on their homes. Retirees who travel can earn money while they’re on vacation through sites like Airbnb. Another option to get extra cash flow is to rent a room, Thornton says.
Downsizing can also save you money. Going from a large family home to a cozy condo or smaller house can reduce utility costs as well as allow you to cash out some equity in your home to fatten your nest egg. For people not ready to sell, there are other options that allow you to tap the equity while keeping the house.
2. They can access home equity, if needed
With working years behind you, having a backup generator of cash is a good thing. There are several ways homeowners can tap the equity in their home without putting up a for-sale sign; two of the most common ways are a cash-out refinance and a home equity line of credit or HELOC.
Equity-rich homeowners who want to lower their mortgage interest rate might consider a cash-out refinance. This increasingly popular option hit peak numbers in the second quarter of this year, reaching $16 billion of equity cashed out, the highest since 2008, according to a report by Freddie Mac.
A cash-out refinance is almost like selling your house to yourself. The bank would cut you a check for the equity, which is the difference between what you owe on the house and the market value. If your home is worth $200,000 and you owe $100,000 then you have $100,000 of equity in the home.
Banks usually limit the amount you get to 80 percent of the total equity. That means with $100,000 in equity, the bank might give you $80,000. The amount you qualify for is usually based on income, credit score and other determining factors.
Now comes the tricky part: when you do a cash-out refinance you’ll get a new mortgage. If your interest rate is high because of poor credit or market conditions and you think you have a chance of getting a lower interest rate with a new mortgage, then a cash-out refinance might be an appealing way to access your equity. However, if your mortgage interest rate increases with a new mortgage then you should consider other options, such as a home equity line of credit, or HELOC.
Something else to keep in mind is the fact that a new mortgage usually means going back to square one if you choose a longer term. If your house is a few years away from being paid off restarting the clock is probably not a good financial move. You’ll end up paying years more in interest and increasing your debt burden.
3. Even with a mortgage, they have liquidity options
For people who want to keep their homes and existing mortgages while tapping their home equity, one alternative is a HELOC.
HELOC lenders use the equity in your home as collateral to extend lines of credit over a fixed amount of time. Like a cash-out refinance, lenders typically cap the credit amount at 80 percent of the total equity. Some places, like Navy Federal Credit Union, go up to 95 percent of the total equity.
The benefits of HELOCs are that you only pay on what you use and the interest is tax deductible if you use it to repair or upgrade your home. For retirees who want to retrofit their homes to make life easier, such as installing stair lifts, grab bars and handrails, a HELOC could be a good way to fund those upgrades and get a tax break.
Before you decide on a lender make sure you understand the terms of the HELOC and any associated fees, says Johnna Camarillo, assistant vice president of equity processing and closing at Navy Federal Credit Union.
Some lenders might charge a service fee or a fee if you have a zero balance. Likewise, some lenders require a balloon payment at the end of the loan, which could put some borrowers in hot water.
Balloon payments are typically large payments owed at the end of a loan. If a borrower hasn’t sufficiently prepared for that payment, then the loan could go into default and you could risk losing your home.
“Before you get a HELOC, ask yourself: can I afford the payments if I max this thing out? Every person is different, so it’s important to look at your budget and not overspend,” Camarillo warns.
Retirees who own their home are going to qualify for a HELOC easier than someone who holds a mortgage, which is beneficial if emergencies come up and you need to borrow a chunk of cash. HELOCs normally have lower interest rates than credit cards or personal loans, making them an attractive option for homeowners.
It’s important to remember that once you use that equity, it will likely take years and even decades to rebuild it.
“Home equity is like a bar of soap — the more you handle it the smaller it gets,” Thornton warns.
Plan ahead for retirement
For folks nearing retirement who still owe on a mortgage, paying off that loan should be high on your list. If you plan on retiring in 10 years, then try to put more money toward your principal or even consider refinancing from a 30-year mortgage into a 15-year mortgage to lower your interest rate and repay the loan faster.
The dual benefits of lowering your living expenses and having access to cash in emergencies are great reasons to sail into retirement without a home loan springing a leak in your budget.
- When is cash-out refinancing a good option?
- The costs and benefits of paying down your mortgage
- Home equity loan compared with home equity line of credit