So you’ve paid off your house and are headed for a mortgage-free retirement. Fantastic! Retiring without a mortgage payment means you can more easily live on a lower retirement income and preserve your retirement savings for longer.
Though retiring mortgage-free is a great accomplishment, it comes with a potentially big problem. And I’m not referring to the “problem” of losing your mortgage interest deduction. Let me explain.
An Unusable Asset
According to US Census data, the typical American’s net worth at age 65 is $194,226. Of that, $150,304 is held in the form of home equity.
Now think about your home’s equity for a moment. What can you use it for? What practical impact does it have on your life? Whether you have a dollar or a million dollars worth of home equity, how does it benefit your daily life in a tangible way?
If you’re retired and have no plans to sell your home, the amount of home equity you have is pretty much just a number on paper. It might be a very nice number, but it has little to no impact on your retirement lifestyle. You can’t take your home equity to the store to buy groceries. You can’t take it to a nice restaurant for a steak dinner. You can’t exchange your home equity for gifts for your grandchildren.
Case in point: there are seniors right now living in paid off homes worth more than a million dollars in the San Francisco Bay area that are barely scraping by on Social Security. They’re technically millionaires, but they can barely afford to pay the light bill!
So, you busted your tail for decades, made mortgage payments month in and month out, kept up with your property taxes, fixed things when they broke, and maybe even upgraded your home a bit. Maybe you got lucky and your home even went up in value since you bought it. You’ve managed to enter retirement with free and clear home and tons of home equity, but you can’t use your equity to enhance your retirement lifestyle. What a bummer!
Having said that, there are ways to convert home equity into cash in retirement. The typical choices are to either sell the home and cash out all your equity (which means you have to find a new home) or do a cash out refinance and be stuck with mortgage payments for the next 30 years. Obviously, neither option is appealing if your goal is to increase your available financial resources and remain living in your home.
If only there was a way to tap into your home equity without having to sell or take on a mortgage payment! How cool would that be?
Well, here’s the good news! You can turn home equity into a liquid retirement asset without selling or taking on a mortgage payment. Home equity actually can have a tangible impact on your lifestyle and financial well being in retirement! How? With a home equity conversion mortgage, or HECM.
What is a HECM?
The HECM (often pronounced heck-um by industry insiders) is an FHA-insured mortgage program created and signed into law back in the late 1980s. If you’re at least 62 years of age, the HECM can allow you to tap into your home’s equity without giving up ownership or taking on a mortgage payment. The following are some notable features of the HECM:
- No monthly payments are required and the money does not need to be repaid as long as at least one borrower (or non-borrowing spouse) is living in the home and paying required property charges.
- You remain the owner of the home and are free to will it to your heirs.
- HECM proceeds are not subject to income taxes and do not impact Social Security retirement or Medicare benefits.
- The HECM is non-recourse, meaning you, your estate, or your heirs will never have to repay any more than the value of the home regardless of how much you borrow.
- The HECM program was created by the federal government and is insured and regulated by FHA.
HECM proceeds can be received in the form of a monthly term or tenure “paycheck”, lump sum, line of credit, or some combination of all.
The line of credit option is what I want to focus on because it can turn a chunk of your home’s equity into what is essentially a tax-free retirement account that is guaranteed to grow and compound larger over time.
The home equity “retirement account”
If your home is paid off (or very nearly so), the HECM could enable you to turn a large portion of your home’s equity into what is essentially a liquid, tax-free retirement account that will grow larger over time. Instead of home equity being a largely “useless” asset that has little impact on your day-to-day lifestyle, it can be put to work to increase your financial well being in retirement.
The HECM line of credit is very similar to a traditional home equity line of credit (HELOC), except that no payment is required and you don’t have to pay back any of the money you borrow as long as you meet your obligations under the program (pay required property charges, live in the home, etc.).
The best part is that the unused credit line will automatically grow and compound larger with no limit based on an annual growth rate.
To see how the growth rate works, let’s take a look at an example. Let’s assume you qualify for an initial credit line amount of $75,000 and the annual growth rate is 5%, which is very reasonable for today’s market. As you can see in Scenario #1, your line of credit will have grown to over $95,000 after just five years. After ten years, it will be worth over $122,000.
Because the growth rate applies to your available line of credit, growth compounds on growth. This means that the available credit in absolute dollar terms can really pile up over time.
The growth rate will also keep up with prevailing interest rates. If interest rates rise in the future, which is definitely possible, the growth rate will increase as well, which means your line of credit will grow even faster. As crazy as it sounds, higher interest rates could actually end up being a good thing for you!
Because there’s no limit on how much the line of credit can grow, it’s even possible it can grow larger than the value of your home! And because a HECM is non-recourse, you, your estate, and your heirs are not on the hook for any shortage if the home is worth less than the loan balance. The most that’s ever paid back is the value of the home, even if it’s worth less than the HECM balance.
If your line of credit ends up growing larger than your home’s value, you’ve officially beat the system!
For another example, let’s assume your line of credit starts off at $150,000 and the growth rate is again 5%. As you can see in Scenario #2, the growth really adds up quick. After just five years, your available credit line will be worth over $191,000. After ten years, it’s worth more than a whopping $244,000!
If you happened to get this line of credit early in your retirement (say at age 62) and left it untouched for 20 years, you’d have just shy of $400,000 available with just a phone call, tax-free.
That adds up to a lot of financial security in a time of life when in-home care or other medical expenses can be a huge financial burden.
Having another asset working hard for you also means you can rely less on your other retirement savings, such as 401Ks, IRAs, etc., and help make those assets last much longer.
You want as many financial options in retirement as possible
It’s a well-known fact that people live a lot longer today than in decades past, so it’s extremely important that your assets last at least as long as you do. Nobody wants to be in their late 80s or early 90s, maybe not in good health, and be out of money. Believe me, I’ve chatted with people in that boat and it’s not a fun place to be. It’s something that many seniors worry about – with justification. It is a very good thing to have as many financial options as possible in retirement.
The HECM line of credit is a powerful financial tool because it gives you options you wouldn’t otherwise have. It enables you to add home equity to the retirement funding picture. Instead of home equity being a largely unusable asset, you can now actually use it to live better and be more financially secure in retirement.
The best part is that the line of credit will automatically grow and compound larger over time – with no limit! So, not only have you now turned an unusable asset – home equity – into a usable one that actually enhances your lifestyle, you’ve also turned it into an asset that performs for you. It grows and compounds larger with no limit – tax free!
Pretty cool, eh? It doesn’t have to be a bummer to retire without a mortgage after all!
