During the credit crisis, we learned that our homes were not ATMs. Millions of Americans continually remortgaged their homes, took second mortgages, or received home equity loans. Every time interest rates dropped and housing prices rose, homeowners withdrew any available equity to fund renovations, tuition bills or vacations. When home prices eventually fell, many homeowners lost their homes or discovered that their debt was larger than the value of their house. Those who had hoped that their home might help to provide retirement security were left to scramble.
After the recession, many aging Americans are wondering whether their home can help to provide for their retirement. The answer is yes. While using a house as an ATM is a bad idea, relying on it as part of a retirement plan is sensible. If you continually pull all the money out of your residence, in all likelihood the cash will be spent. Then you’ll wind up with a huge mortgage at the point when you would like to retire. So the first lesson in making your home a component of your retirement plan is to slowly pay down the mortgage so there’s equity in your home when it’s time to stop working.
Homes regaining some value
Your options for using your home as part of a retirement plan haven’t changed. Indeed as the real estate markets recover, homes are regaining some of their value as a potential retirement asset. However, the lending environment is stricter and more regulated than it was before the credit crisis. Thus, you are likely to find that less value can be extracted from your homes than was possible a decade ago.
Many of you plan to downsize, relocate to a less expensive market, or move into assisted living. The goal, of course, is to extract some of the equity from your residence to supplement Social Security, your 401(K) balance and other savings. Nevertheless, it pays to be conservative when weighing this option. Buying and selling houses doesn’t come cheaply. Between real estate commissions, transactions taxes and closing expenses, roughly 10 percent of your money is likely to disappear. Moreover, if the new home is going to carry a mortgage, assume that the bank will require a substantial down payment, especially if you are retired.
If you decide to remain in your home, you have two basic choices in pulling out equity to fund retirement: Take out a mortgage or get a reverse mortgage. Both a mortgage and a reverse mortgage provide cash. The mortgage requires you to immediately turn around and begin to service the debt and interest. If the house falls in value, you may wind up with a loan balance that is greater than the value of your house. Moreover, the debt service payments may eventually become onerous if living expenses increase as you age.
Reverse mortgage still a novelty
The reverse mortgage also enables you to extract value from the house. However, the interest and principal on the reverse mortgage only come due when you or your estate sells the home. The obligation, though, can never be greater than the value of the property. Typically, the reverse mortgage is taken as a lump sum to pay off an existing mortgage. Only a small group of borrowers utilize the reverse mortgage as it was originally intended by receiving a monthly payment, similar to an annuity. The longer the borrower lives, the greater the loan balance, and therefore the smaller the amount of equity that will be left when the home is sold.
While most are familiar with conventional mortgages, the reverse mortgage is still a novelty. When considering one of these loans, you have to pay close attention to the fees and the fine print. Moreover, you must intend to stay in your home for more than a few years. If you don’t pay attention to the details, or if you decide to move shortly after taking the loan, you’re going to discover that the reverse mortgage was an expensive mistake.
New FHA regulations
The Federal Housing Agency is in the throes of developing new regulations that might make it more difficult to qualify for a reverse mortgage and limit the amount of money that can be extracted from a home. Historically, homeowners weren’t required to undergo credit checks before receiving a reverse mortgage. The value of the home was seen as sufficient collateral to protect the lender. However, during the credit crisis, many homeowners were unable to keep up with their property taxes and insurance payments. As a result, they lost their homes, and the lenders suffered losses. So the FHA is considering credit requirements. In addition, the agency is looking to limit the amount of money that can be extracted through reverse mortgages. At this juncture it is too soon to say exactly how useful and/or onerous it will be to get a reverse mortgage.
If you are just purchasing your first home, you might think long and hard before buying as much house as you can possibly afford. Before the recession, many folks figured that their house was the safest of investments and would eventually provide a substantial part of the money needed for retirement. Even if the 401(K) balance were paltry, the homestead would ride to the rescue in 30 or 40 years, so why not buy the biggest possible house. Today, a prudent person makes sure that they aren’t only counting on real estate; they are also setting aside money to fund their retirement.
Andrew Silton’s Meditations on Money columns can be found twice a month in The N&O’s Work&Money section. He is a retired money manager living in Chapel Hill and a former CIO for the North Carolina Retirement System. He writes the blog http://meditationonmoneymanagement.blogspot.com/