How to Effectively Use Home Equity in Your Retirement Plan
Every American worker understands that there will come a time when they must cease working and enter retirement. However, for many, the prospect of retirement is daunting, primarily due to concerns over not having sufficient savings and investments to support the income required during their retirement years.
A report by CNBC noted that about 59 percent of Americans think working longer than retirement age can help them save enough, while 36 percent believe they can’t save enough for retirement.
Data from the Retirement Industry Trust Association (RITA) revealed that one in 12 Americans believe they will never retire.
People with savings plans for retirement are also faced with the impact of inflation and fear of outliving their savings.
Home equity can be a saving grace for about 66 percent of Americans who own their own home.
What is home equity?
Home equity is the percentage of a home value possessed by the owner. Individuals that purchase a home outrightly without a loan may have 100 percent home equity.
If you buy a home with a mortgage, the down payment will be equivalent to your home equity. Therefore, the equity grows as mortgage payments are made.
With home prices rising significantly over the years, home equity may be a good source of funds for your retirement plan.
How much do I need for retirement?
The amount you will need to sustain your retirement depends on the lifestyle you plan to enjoy during that time. Medical expenses and life expectancy are other things to consider.
The retirement age in the U.S. is 62 years old, even though most workers are expected to retire between the ages of 64 and 67.
Also, thanks to medical advancement, life expectancy had increased to about 85 years old, unlike in 1940 when it was estimated at 79. This means retirees today will need more savings than those of the 1940s.
A retiree is estimated to spend $4,300 out-of-pocket on health care expenses yearly. Meanwhile, your current level of health risk will greatly impact how much you spend annually.
Ways to use home equity in your retirement plan.
If you own most of your home equity, tapping into it to help reach your retirement goals can be a good move. There are different ways this can be done.
Reverse mortgage
A Reverse Mortgage is a special type of home loan only available to homeowners at least 62 years old. It is similar to a traditional mortgage, except you are not obligated to make monthly repayment in this case.
The title of the home will remain in your name. The loan is repaid when the borrower no longer lives in the home, probably due to death, relocation, or moving to a care home.
Types of reverse mortgages
- Single purpose: The approved loan is expected to be spent on a specific purpose. This kind of loan is less common and charges the least interest because it is backed by state or local governments and sometimes nonprofit organizations.
- Home Equity Conversion: It is insured by the Department of Housing and Urban Development (HUD). The eligibility criteria are easy to meet as no income limitations or medical requirements exist. You can use the loan for any purpose you deem fit.
- Proprietary: This is backed by private lenders and usually offers loans above the lending limit of federally insured home loans.
Home equity loan
A home equity loan, also called a second mortgage, allows homeowners to take a loan using their home as collateral. The eligible about is determined by the borrower’s total equity in the home after an appraisal. Typically, lenders will borrow 80 to 90 percent of the home equity.
It is a fixed-rate loan with a loan term of five to ten years. The ash can be spent the way you prefer. However, it is vital that you do not default on the repayment schedule, as the lender may force you to sell your home to recover the loan.
Home equity line of credit
Unlike a home equity loan, the home equity line of credit is not offered in a lump sum. The lender will approve the eligible amount based on your home equity, and you can access it whenever you need it within the draw period.
The interest rate is not fixed and not charged unless you use any portion of the credit line.
It is suitable for homeowners that only need backup funds for their retirement plan.
Renting and downsizing
You can rent out part of your home to generate income for retirement. Another alternative is selling the home since you may need a smaller space for retirement.
Purchase a smaller home and use the extra cash to fund your retirement.
