According to Census Data from 2013, home equity composed 66% of wealth for those aged 65 to 69, 70% for those aged between 70 to 74, and 76% for those aged over 75. This data is 10 years old, but it would be a very safe bet to assume those numbers are significantly higher today.
Housing wealth or home equity is a massive part of the overall wealth people have access too during retirement. Yet very few retirees have any plans to utilize it during their retirement.
There are several reasons why people ignore home equity during retirement.
The first and probably most common reason is people want to leave the home to their heirs. I totally understand that. As a parent I want to leave a nice inheritance for my two daughters. The reality, in most cases, the heirs don’t want the home. They want the equity, but they don’t want the home.
I have met and had conversations with clients that were very low income, living on less than $800 a month. They chose not to move forward with a reverse mortgage. They chose to continue to struggle and financially sacrifice for the next 10 to 20 years so they could leave the home to their kids.
If you are one of those people that want to struggle financially during your retirement just to leave your home to your kids free and clear, here is some sobering information.
According to research completed by Jay Zagorsky published in the March 2013 issue of Journal Family and Economic Issues, only half of inheritance is saved. The other half is spent or lost. Over 35% of people that received an inheritance saw a decline or no change in their wealth. Over 20% of people that received an inheritance spent it all. If half of inheritance is spent or lost, you might as well spend it yourself and improve the quality of your life.
I’ve also met with clients that were doing well financially and moved forward with the reverse mortgage. There were a variety of reasons. Some said their kids were set financially and they weren’t worried about them. Some said they had sacrificed enough for their kids and now it was time to take care of themselves. Others had very candid conversations with their kids and the kids were supportive of whatever they needed to do to have a good retirement. I even had one client who said, “If I don’t fly first class my kids will.”
The reality is this, you may or may not leave a home with equity to your kids if you get a reverse mortgage. However, as you will see in the strategic uses, you may be able to leave them a larger inheritance by getting a reverse mortgage.
The second reason home equity gets ignored is because it is a really weird and awkward asset. It represents a significant portion of wealth for most retirees, yet it is basically illiquid.
There are only two ways to use home equity, which are to sell the home or borrow the equity. Obviously, if you sell the home you still need a place to live. If you borrow it, traditional loan options will come with monthly payments. Because everyone still needs a place to live and nobody wants mortgage payments during retirement, home equity gets ignored.
Third, the thought for most people, including their advisors, is that home equity is a backup plan. The backup plan is that home equity is there in case of an emergency.
There’s an emergency. Now what? You must sell the home or borrow against it. If you sell the home, you still need a place to live. If you borrow it, you now have monthly mortgage payments which could exacerbate the emergency or problems you are facing.
It’s ironic. People don’t want to use home equity because of the risks associated with traditional methods and want to keep it in case of an emergency. Yet, when there is an emergency, it puts them in the very financial risks they were trying to avoid in the first place.
The other thing people don’t take into consideration is whether they would qualify to borrow home equity at some point in the future. If there are credit or income problems, they may not qualify for a loan. If they can borrow their home equity, it may be in very limited amounts which may be insufficient for their needs.
If home equity is the largest asset for most older homeowners, why does it get ignored? And why does it get ignored when it could significantly improve the quality of retirement.
The reason equity gets ignored is because people view their home and the equity as something sacred. They think you should never use home equity except as a last resort. Here’s a question for you to ponder.
What is the difference between spending
home equity versus spending retirement savings?
Why is it okay to spend the money saved for retirement but it unacceptable to spend home equity? They are both assets, they both represent wealth, they are both investments, they both can be spent, and they both reduce your net worth as they are spent.
I had a client that bought their home 45 years ago for $27,000. The home was worth $700,000 when they got their reverse mortgage. With the reverse mortgage they were able to get access to $375,000 in cash.
What if instead of buying that home for $27,000 45 years ago they invested that money? At a 6% return they would have access to $371,000.
In the example above, the client accessed $375,000 from their home income tax free through a reverse mortgage. (consult a tax professional) But, if they invested that initial $27,000 in a mutual fund, it grew to $375,000, and drew it all out. They could pay as much as 25% (state and federal) in taxes netting only $277,250.
The reverse mortgage solves the equity problem. It gives you a way to use and spend the equity you have built up in your home without you needing to sell or impacting your budget. If there is an emergency, the reverse mortgage is there and waiting to help.
There are a variety of different ways the reverse mortgage can be used to lower your financial risks during retirement, increase the likelihood of leaving a larger inheritance, reduce your chances of running out money and provide a better retirement experience.
