Do you want more money for retirement? Many homeowners consider using their home equity to fund their retirement to ensure they have enough money to enjoy their golden years. However, before moving forward with their plan, they want to know if it is a smart move or risky business. Deciding to use your home equity to fund your retirement can be beneficial; however, sometimes, it is too risky and should be avoided.
Arming yourself with relevant information and discussing your options with industry professionals will put you in the best position to choose a good match for your financial situation.
Below I’ll cover the benefits and drawbacks of using your home equity to fund your retirement.
What Does It Mean To Fund Your Retirement With Your Home Equity
Your home equity is the difference between the value of your home and the amount of money you still owe on your mortgage. If your home value is $500,000 and you owe $300,000, your “home equity” is $200,000.
Using your home equity to fund your retirement means you tap into your $200,000 and apply those funds to your retirement plan.
Requirements For Funding Your Retirement With Your Home Equity
Here are four requirements that should be in place for you to consider funding your retirement with your home equity.
Do you have enough equity?
Having enough equity is the very first thing you should determine. Use your House Numbers home wealth management account to assess your home’s value and home equity.
If you have enough home equity, how much should you consider using? You should never take more than you need. So, if you have $500,000 in equity but only need $100,000, then only obtain the $100,000.
Are interest rates low enough?
When deciding if current rates are low enough to use your home equity, you first want to check current market rates. Locking in a low-interest rate is integral to using your home equity to fund your retirement. House Numbers will help you shop multiple options to ensure the best possible financial outcome for you and your family.
What is your plan for the funds you receive?
A key aspect of funding your retirement with your home equity is to have a clear plan with the funds you obtain from your home equity. This is where your financial planner comes in and can establish multiple options for you to consider.
Your options should include an anticipated return on your investment. This is needed for multiple reasons, including a cost-benefit analysis to ensure that funding your retirement with your home equity makes sense.
Does a cost-benefit analysis show a benefit to you?
What is a cost-benefit analysis? According to Harvard Business School: A cost-benefit analysis compares the projected or estimated costs and benefits (or opportunities) associated with a project decision to determine whether it makes sense from a business perspective.
It’s wise to consider using your home equity to fund your retirement if a detailed cost-benefit analysis shows a potentially positive outcome. You’ll have data points such as interest rates, costs, and anticipated returns within this analysis.
When You Should Avoid Funding Your Retirement With Your Home Equity
Here are the times you should avoid funding your retirement with your home equity.
When you are supporting a lifestyle above your means
While home equity can be a valuable resource for funding retirement, it is crucial to avoid using it to maintain a lifestyle above your means. Continuously overspending and relying solely on home equity can lead to the depletion of your equity, increased debt, and an uncertain financial future. If you continue to spend more than you make each month, relying on your home equity to bridge the gap, you will eventually deplete your equity while still failing to address the underlying problem. This can complicate your financial situation and hinder your ability to enjoy a stress-free retirement.
Interest rates are too high
When interest rates are high and your anticipated investment return is low, using your home equity to fund your retirement does not make sense. Avoid feeling pressured to fund your retirement at this point, and set up a plan for when interest rates are lower.
The cost of tapping into your home equity is too high
You should never pay a ton of fees to tap into your home equity. Some lenders offer really low rates hoping the homeowner forgets to review the cost to obtain the low rate. I suggest homeowners always ask for the total amount of the fees being charged and an itemized breakdown of each fee charged by the lender. Then with this information, you can decide if the fees are reasonable or too high.
You plan on investing in a company or an idea you hope will bring “big” returns.
If you are going to utilize your home equity to fund your retirement, stay away from risky investments. In fact, I suggest you not consider moving forward if this is your plan. Remember, this is a long-term investment that you will need when you have no other income. Gambling your future on a long shot is simply not worth the risk.
Cost-Benefit analysis shows little benefit
If you do not see a benefit after completing your cost-benefit analysis, you should not fund your retirement with your home equity. Your next step should be to work with your loan officer, financial planner, and CPA to see which component is causing the result and then set up a plan to resolve the issue.
If interest rates are too high, establish what interest rate level you would need to see a benefit. If it’s the cost to access your home equity, maybe obtain two or three more quotes or wait until the market adjusts before moving forward.
Home Equity Loan Options For Retirement
You can use many options to tap into your home equity to fund your retirement.
Cash-Out Refinance
A cash-out refinance means you refinance your current first mortgage and receive additional funds once the refinance process is closed. Here are the two most popular first mortgage programs for those looking to complete a cash-out refinance.
Conventional
A conventional loan is the most popular cash-out mortgage option for homeowners. Under the conventional loan option, you have conforming home loans (loans that “conform” to Fannie Mae and Freddie Mac guidelines), jumbo mortgages, and portfolio mortgage products like a Bank Statement mortgage program.
Government Backed Mortgage
A government-backed mortgage is a mortgage that is “guaranteed” by the United States government. The three main options under the government-backed mortgage umbrella are FHA home loans, VA home loans, and USDA home loans.
Home Equity Line of Credit
A Home Equity Line of Credit, commonly called a HELOC, is a loan product a bank provides for homeowners to access their home equity as needed. For example, let’s say you want to borrow $100,000 to help fund your retirement. With a HELOC, you can get a total of $100,000 at once or draw it down over time. And as you pay back the amount you owe, your balance owed and monthly payment go down, and you can re-access the credit line if you need to.
Keep in mind that most minimum payments with HELOCs are interest-only payments for the first ten years. So if you want to pay down the balance each month, you’ll need to pay more than the minimum payment.
Pro tip: If you are going to borrow $100,000 using the HELOC program, make sure your total line amount is more than $100,000 (ideally double, so $200,000). The reason is that your credit score will be negatively impacted if you have a HELOC with a total line of $100,000 and you borrow the full amount.
The credit bureaus consider it a maxed-out credit card (something you should never do).
Home Equity Loan
A Home Equity Loan is a fixed-rate second mortgage. The benefits compared to a HELOC are that the interest rate and monthly payments are fixed. The downside is that you can’t re-access a credit line (like you can with a HELOC).
If you like stability and certainty and know you will not need additional credit in the future, then a Home Equity Loan is a better option than a HELOC.
Home Equity Investment
A Home Equity Investment (HEI) is a relatively new product designed to provide cash to homeowners who don’t want to obtain a traditional mortgage. With an HEI, you essentially sell a portion of your equity to an investor and share in the profit of future equity gains. Also, you typically avoid making a monthly payment which is a significant monthly savings compared to the traditional loan programs mentioned above.
Credit score and income are not a part of the evaluation process, and that’s a significant benefit to some homeowners.
Reverse Mortgage
A Reverse Mortgage is a mortgage product for those 55 or older. Per the Consumer Financial Protection Bureau;
A reverse mortgage loan, like a traditional mortgage, allows homeowners to borrow money using their home as security for the loan. Also, like a traditional mortgage, when you take out a reverse mortgage loan, the title to your home remains in your name. However, unlike a traditional mortgage, with a reverse mortgage loan, borrowers don’t make monthly mortgage payments. The loan is repaid when the borrower no longer lives in the home.
There are some significant benefits to a Reverse Mortgage but also some drawbacks. As for the benefits, you get to stay in your home as you age, and you don’t have to make a monthly mortgage payment.
As for the drawbacks, fees and rates are higher than other mortgage products, and the process can be complicated if you are not working with a knowledgeable loan officer. Also, fees from when you closed the original loan and future interest amounts that are owed are all added to the balance of the original mortgage (since you do not have to make a monthly payment).
Funding Your Retirement With Your Home Equity FAQs
Here are some typical questions homeowners have about funding their retirement with their home equity.
Should I Renovate My Home Before Accessing My Equity For My Retirement?
This a great question because, in some cases, a renovation will significantly increase the home’s value. But not all upgrades increase your value. The best thing to do is talk with your realtor and loan officer to determine if your renovation will increase the value of your home and, if so, by how much.
Also, if you are doing a large-scale renovation, are there comparable sales in the area to support the new “anticipated” value? For example, if you have a 2,200 square foot home and plan on adding another 1,000 square feet to the house, are there nearby closed sales with 3,200 square feet?
If not, you may not want to increase your square footage since it will be hard to support an increase in value with no comparable sales.
Pro tip about renovations: Ensure you have completed your renovation before applying. Why? Because if you need an appraisal, and you probably will, the uncompleted renovation will appear in the appraisal report. And if that happens, it’s almost 100% certain the lender will not fund the loan until you have completed the renovation.
What Are The Tax Implications For Using My Equity To Fund My Retirement?
Taping into your equity and using the money to fund your retirement is something you should discuss with your CPA (or tax attorney) before making any final decisions since there may be tax implications that you are unaware of. As a general matter, money you receive from a loan against your home equity is not taxable, though, because it must be paid back.
Should I consult with a financial planner before tapping into my home equity?
Absolutely. It can be helpful to first talk with a mortgage professional (like those at House Numbers!), financial planner, and CPA (or tax attorney).
Is Funding My Retirement With My Home Equity Right For Me?
Funding your retirement with your home equity is a decision that only you can make. Making sure you have enough equity and doing a cost-benefit analysis are key to the decision-making process. There are many different loan options for homeowners to consider, and it’s essential to make sure those loan options lead to a benefit to the homeowner.
If it appears too risky, or the costs out weight the benefits, hold off on using your home equity to fund your retirement and wait until the outlook improves. No two situations are the same.
