For many Americans, saving and investing for retirement can be a stressful undertaking. According to data from the Retirement Industry Trust Association (RITA), one-third of American workers report feeling unsure of whether their retirement will be secure, with one in 12 Americans believing that they will never retire at all.
At the same time, about 65% of Americans own their own home. And with home prices rising significantly in recent years, home equity may increasingly seem like an attractive and necessary source of wealth for planning your retirement. Like everything in finance, however, there are pros and cons to using your home equity to fund your retirement and investment goals.
- Many Americans have significant home equity while struggling to save for their retirement.
- Home equity loans, home equity lines of credit (HELOCs), and reverse mortgages can help bridge this gap.
- However, these products have pros and cons, and they may not be suitable for all homeowners.
The Basics of Home Equity
To start with, it’s important to get a handle on what home equity really means. Essentially, home equity just refers to how much of your home you really own. If, for example, you could sell your home for $250,000, but you have a mortgage for $150,000, then your home equity would be the difference between the sale price and the mortgage—$100,000 in this example.
Homeowners will naturally see the equity in their home rise over time, because they pay off a portion of their mortgage principal with each payment. Eventually, their mortgage is paid off and their home equity will be equal to the value of their home.
Home equity can help you invest for retirement because there are various ways that you can use it to raise cash. This cash can then be saved or invested in a variety of ways. Although many options are available, what works best will depend on your personal financial situation, goals, and risk tolerance.
Ways to Raise Cash from Your Home
The simplest way to raise cash from your home is, of course, to sell the home and simply pay off your mortgage. The advantage of this approach is that it can provide a large lump sum, especially if your house has appreciated in value. The disadvantage is that it can lead to significant transaction costs and capital gains.
Typically, homeowners will pair this strategy with a downsizing approach in which they then purchase a smaller and less expensive home, pocketing the difference between their original sale proceeds and the cost of their new down payment. This strategy is popular among more elderly homeowners, who may find that, in any case, their original property was larger than necessary or difficult for them to physically navigate.
If you don’t want to sell your home, another option would be to borrow against your home equity. This can be done in many ways, but three popular approaches are getting a home equity loan, taking out a home equity line of credit (HELOC), or using a reverse mortgage.
Home Equity Loans
When you take out a home equity loan, you receive a lump-sum payment that is equal to a certain percentage of your home equity. The loan is repaid on a fixed term, where each includes both interest and principal. Essentially, it is the same basic structure as a typical mortgage except that you receive the proceeds as cash rather than having it applied toward the purchase of a home.
Home equity loans typically use fixed interest rates, with much lower rates of interest than unsecured loans such as credit cards. That’s because home equity loans are secured by your home, meaning that if you fail to make your payments, you could face foreclosure.
Home equity loans could be used to fund your retirement by either saving the cash to fund your lifestyle or investing some or all of the cash in other income-generating investments. For example, a retiree could take out a home equity loan and use it to purchase a second property that could help fund their retirement through rental income.
Home Equity Lines of Credit (HELOCs)
HELOCs are similar to home equity loans but have a few key differences. First, HELOCs carry variable interest rates, which means that you could see your payments increase if interest rates rise during the life of your loan. Second, HELOCs allow you to borrow or repay funds whenever you wish, only requiring you to pay the interest on the funds borrowed.
Eventually, however, the HELOC loan switches into requiring you to repay the principal as well. Therefore, it is important to understand and plan for this beforehand. Also, bear in mind that HELOCs are (just like home equity loans) secured by your home, meaning that there is still the risk of foreclosure.
For some homeowners, borrowing against their home might be scary, especially if there is a chance that they might not be able to make their payments. This is particularly understandable for retirees who may have no income at all aside from their pensions, and especially for those who may not have a pension at all. For people in that situation, reverse mortgages could be an attractive option.
These are a type of loan in which you do not make any monthly payments. Instead, you receive a pension-like stream of payments that are paid for by gradually deducting a portion of your home equity. When you die or sell your home, the lender is repaid for the value of all those payments, plus interest. In that sense, a reverse mortgage is similar to selling your home gradually, while still allowing you to live in and retain title to your home while you are alive.
There are many types of reverse mortgages, and some can include complex terms and fee structures. All of this makes it very important to carefully study the specific products and lenders in question. In some cases, however, this type of product can provide a “one-stop” solution for a homeowner’s retirement savings needs.
Can you use a home equity loan for anything you want?
Yes, you can use a home equity loan any way you wish. Keep in mind, however, that there can be tax benefits to using a home equity loan for purposes that enhance the value of your home, such as paying for renovations, including accessibility improvements.
Can a home equity line of credit (HELOC) be used for investing?
Yes, the proceeds from a home equity line of credit (HELOC) can be used for investing. In fact, many real estate investors use their HELOC to cover the down payment on new properties. However, there are risks involved in doing so, so it is important to always act according to your own means and risk tolerance.
Where can I find reliable information on home equity loans?
There are many resources available online that provide reliable information on home equity loans. One notable example is the Consumer Advice website operated by the Federal Trade Commission (FTC). This website offers a range of articles on financial products, including home equity loans, HELOCs, and reverse mortgages.
The Bottom Line
The question of what is the right way to use home equity to achieve your retirement goals—or whether to even do so at all—will always depend on your specific personality and goals. Realistically, there is simply no one right answer, as what works for one person may not be well suited for another.
However, if you are comfortable with making and managing investments, and if you are willing to get creative, there are likely ways to effectively use your home equity as part of your retirement plan. For example, instead of simply selling your home and downsizing to a smaller property, you could instead keep your home and use your home equity to purchase a second property. You could then either live in the second property and rent out your first home, or take the opposite approach, renting out the second property.
On the other hand, if you are conservative financially and have limited risk tolerance, you may prefer an approach that keeps things as simple as possible. In that scenario, a well-chosen reverse mortgage could be a good fit, as long as it is chosen from a trusted provider. In either case, enlisting the help of a qualified and reputable financial professional may be well worth the cost.