Housing wealth represents U.S. retirees’ largest asset. For the average 65-year-old couple, home equity represents about two-thirds of their total wealth. The only other potentially more important retirement asset is Social Security, since it functions as the main source of retirement income for most retirees.

While there is ample discussion and financial advice focused on Social Security optimization and claiming strategies, home equity is often ignored as a financial asset and potential income source in retirement. Just look at some recent findings published in the Journal of Financial Planning indicating that financial advisors are for the most part ignoring home equity as an asset to support a retirement income plan. However, the article also showed that only about 25% of retirees feel comfortable spending home equity as an income source. Even if only 25% of retirees are willing to strategically use home equity in retirement, advisors cannot continue to ignore home equity as part of the equation. (For related reading, see: Why Home Equity Can Be an Income Source in Retirement.)

5 Functions of Home Equity

For homeowners, home equity can essentially serve five different functions in retirement: housing services, cash flow, long-term care funding, legacy asset and investment diversification. The most important function of home ownership in retirement is that it provides housing services. Everyone needs a place to live and owning one’s own home has always been the most popular retirement housing option for Americans. The aforementioned study showed that roughly 84% of retired homeowners want to continue aging in place in their current homes while only 5% want to rent.

Home equity can also be turned into retirement income to support the homeowner’s standard of living in retirement. There are a number of ways to tap into home equity to improve cash flow. One option is downsizing. By selling their home and buying a cheaper one, homeowners can free up some home equity to spend on other retirement goals. This, though, requires the individual to relocate. For those who want to age in place, an option is to rent the home to generate additional income, similar to the set up in the TV sitcom, “Golden Girls.” The homeowner, however, might not feel comfortable sharing his or her home even if it means improved cash flow.

Reverse Mortgages

Another option for generating retirement income and improving cash flow is to tap into home equity through a reverse mortgage. A reverse mortgage can be an extremely valuable tool for retirees. While reverse mortgages have had some issues in the past, the government has continued to improve and update the product over the past decade. The reverse mortgage product that exists today is far less expensive and more economically secure than anything that existed before.

In the past, many homeowners stayed away from reverse mortgages because the terms were misunderstood. The most common misconception about the reverse mortgage program is that the bank takes your house after you pass away. Addressing this misconception, Alex Pistone, president of Retirement Funding Solutions, a national reverse mortgage lender, has this to say: “A reverse mortgage is just a mortgage, but with unique and flexible terms. The homeowner can make payments if they choose to, but none are required. They have all the rights of homeownership, including the ability to refinance or sell the home. The homeowner retains title and rights to the equity in the home. At time of death, the home goes to their heirs, not to the bank.” (For more, see: 5 Signs a Reverse Mortgage Is a Good Idea.)

What this means is that the current reverse mortgage product deserves a second look by many homeowners. With a reverse mortgage, you borrow from a lender with your home as the backing. Unlike a traditional mortgage, you never have to pay back any debt that equals more than the value of the home and you are not required to make monthly payments. Homeowners keep title of the home and are able to take withdrawals in a lump sum amount, set up a line of credit, or set up systematic payments in a tenure option that functions like an annuity.

A Long-Term Care Funding Tool

If the homeowner does not feel comfortable spending down home equity as an income source, there are other ways to utilize the home value in retirement. While roughly 70% of seniors will need long-term care at some point, only about 7% of seniors have long-term care insurance. The home can serve as a long-term care funding tool. If the homeowner needs to move into a nursing home, or continued care retirement community or assisted living facility, the home could be sold to support the costs associated with institutional care. While this may not be the most efficient long-term care funding strategy, it might be a more palatable situation for some homeowners.

A Legacy Asset

Home equity can also be used as a legacy asset. Many homeowners want to leave a legacy to their children. The home, as their largest asset, could be perceived as the best legacy to leave behind for their heirs. Most adult children, however, do not actually want the parents’ home, they want the value of the home. Very few children who inherit a parent’s home ever move into the house. Instead, most often the children sell the home and, in many cases, sell it below market value to unload the asset and wrap up the estate. Nonetheless, much wealth has been accumulated in real estate and homes, so this is a natural part of wealth transfer and legacy planning goals.

Diversification of Income

Home equity can be used more effectively to support a retirement income plan through diversification of income sources. Many retirees rely on Social Security and a systematic withdrawal approach from an investment portfolio. However, if the market drops 30% to 40% in a year, research shows that selling investment assets at that point to support a retirement income need greatly decreases the longevity of the investment portfolio.

Setting up a line of credit or reverse mortgage line of credit can create a buffer or non-market correlated asset that can be utilized during down markets to help protect the longevity of a retirement investment portfolio. The concept is simple in some ways. Would you rather borrow from your house at 4% for a year or sell stocks that dropped 40% that year? The math works out in favor of borrowing in that situation. Using home equity in certain situations helps create diversity of income so that retirees can reduce reliance on market returns.

An Untapped Resource

Home equity is the largest untapped resource for retirees. When used correctly, it can support a more secure and happier retirement. When considering using home equity in retirement, you will find that there is no one-size-fits-all strategy. Instead, home equity can function differently for homeowners with different goals and concerns. Additionally, products like a reverse mortgage remain vastly underutilized today. When used in conjunction with a comprehensive retirement income plan it can be a saving grace for retirees who are just getting by with limited savings and Social Security benefits. (For more, see: Is Relying on Home Equity for Retirement a Good Idea?)

Jamie Hopkins is Co-Director of the Retirement Income Program and an Associate Professor of Taxation at The American College of Financial Services, a non-profit, accredited, degree-granting institution in Bryn Mawr, PA that has educated one in five practicing financial advisers in the U.S.

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