Tapping Into Home Equity to Fund Retirement
Welcome back to Efficient Markets
On today's episode, I spend some time on the topic of home equity. Many Canadian retirees are looking at their accumulated wealth in their homes and thinking of this as a supersized retirement fund. Is this a sensible approach to retirement planning?
I discuss some of the benefits of looking at Home Equity as part of your retirement plans, which include:
Benefits
1) Tax Effectiveness - home equity when converted to borrowed money in the form of a loan or line of credit, or proceeds from the sale of the home, is tax-free money in Canada. Using home equity effectively can have tremendous tax efficiency
2) Rising Home Prices - homeowners in many parts of Canada have benefited from a windfall of wealth due to their home ownership. This housing wealth boom has provided soon-to-be retirees have a lot more options than they did a generation ago.
3) Options - retirees have a lot of options to consider when they think about how they want to tap into home equity. They can do the traditional downsize - which involves selling their home, purchasing a new/cheaper home, and then investing and spending the difference. Retirees can also look at options including home equity lines of credit and, more recently in Canada, reverse mortgages
From there, we go into some more detail about what a reverse mortgage is, how it works, its growth in Canada, and some of the key differences between reverse mortgages and traditional lines of credit.
We end the episode with some of the drawbacks of looking at home equity exclusively to fund your retirement.
Big Issues
1) Past returns of real estate do not forecast future returns - while home prices have skyrocketed over the past couple of decades in Canada, we need to remember that prices can go up AND they can go down. If you are banking on the recent price increases to continue indefinitely, and you are not otherwise saving for your future retirement, you may be in a risky situation when/if house prices correct downward.
2) Downsizing may not be what you want - downsizing to a condo or an apartment may seem like something you are prepared to do while you are in your mid-career, healthy, and active. But, you may feel differently when you eventually retire. Many retirees want to stay where they are and do not want to downsize when they enter their 70's and 80's. Be aware that your preferences may change over time. An important caveat is that this issue is only an issue for the "downsizer". The HELOC or reverse mortgage borrower is already planning to stay where they are
3) Lack of a Safety Net - if you downsize or borrow against home equity to fund the early part of your retirement, you may be taking on the risk that poor health and the need for expensive medical care goes unfunded in the latter portion of your retirement. If one spouse needs to go into assisted living, and the couple has borrowed heavily against home equity (or sold completely), the couple may find themselves in long-term retirement income jeopardy. For retirees who don't tap into home equity as part of their regular spending plans, they have the home to "fall back on" like a supersized emergency fund. For retirees who tap into those reserves to spend more heavily in the early part of retirement, there is certainly risk that needs to be discussed and planned for. A caveat here is that there are still some insurance products available in Canada that can be used to provide funding if the policy holder loses the ability to take care of themselves in retirement. An advisor will be able to help you determine if there is a good fit here for you or not.
Recommendations
1) Talk with your spouse and loved ones about how you want to live your life in retirement. Don't assume that you will be ok with downsizing or tapping your home equity to fund retirement. You may not feel the same way about that decision when you do, eventually, retire. Is your spouse comfortable with the idea of moving to a smaller place? And, what will you do if one of you becomes ill and needs special care? Make sure you have thought about how you will address this situation
2) Plan it out. A financial planner can help with this type of planning. But, you can get started on your own. Spend some time educating about the different types of healthcare options that are available and desirable to you in your area. And consider how you would fund those needs if you and/or your loved one needed care.
Links/Resources
https://www.moneysense.ca/save/retirement/how-does-reverse-mortgage-work/
