Earlier this decade, many homeowners overbought or over-borrowed, treating their home as if it were an ATM. This dangerous attitude was premised on a false belief (or hope) that constant increases in home values and home equity were a sure thing.
Then 2008 happened.
The home you live in is not a true investment and should not be treated as such. Nevertheless, if you are a homeowner, here are three ways you can still use your home equity to help fund your retirement.
1. Sell and rent. The real estate market is flat (at best) in most areas of the country and may decline in others. This means that your equity is not increasing. You can use existing equity to generate retirement income by selling and investing your net proceeds. Then you rent instead of buy. Real estate experts have identified many cities where renting makes more financial sense than buying. An extra bonus from this strategy is that when you sell your primary residence, the capital gains are tax free (up to statutory limits).
2. Receive tax-free income. A house is a home, but it is also a source of what economists call shelter services. Shelter services are a necessity, not an option. You can receive them from a house you own, a rental apartment, friends, family, or even a homeless shelter. If you rent or have a mortgage, you need to pay for those services, typically using earned income. Generally you will also pay income taxes on that income.
Now imagine a home with no rent or mortgage payment. You still receive shelter services but those services are free because you do not need cash flow to pay for them (excluding property taxes, insurance, and maintenance costs, which are typically much lower than mortgage or rent payments). Because you don’t need income to pay for your shelter services, you won’t be paying any income tax for receiving those services. That will come in handy when you are retired and trying to keep your investment income down so that you can maximize your Social Security benefits. If you don’t need as much other income because you are receiving free shelter services, you can reduce the tax impact on Social Security retirement benefits.
You can achieve free shelter services status by working diligently to pay off your existing mortgage or by downsizing into a home that you can afford to buy for cash.
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3. Reverse mortgage. Some retirees are house rich but nest egg poor. A preferred solution to this problem is selling and renting or downsizing. For those determined to stay in their home, reverse mortgages are available. Reverse mortgage products can be complicated and costly. I would wait on this move until all other options are exhausted.
Mark Patterson is an engineer, patent attorney, baby boomer, and author of The Failsafe Retirement System. He blogs on matters of personal finance and retirement planning at Tough Money Love and Go To Retirement.