Mo Vidwans
By Mo Vidwans
According to the Federal Reserve Bank of Philadelphia, individual home equity accounts for almost half of the median net worth of retirees, depending on age. Collectively, homeowners aged 62 and older have a record of $6.5 trillion of tappable equity. These days we have heard that word Trillion more often than ever before, courtesy of what our Federal Government is trying to do for this country but believe me that is a very large number.
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Many Financial Planners would say and do believe that tapping the home equity wealth in retirement, at least seriously considering it, makes sense if done wisely for the right reasons and even more importantly the right way. For example, that money can be used to pay off high-priced credit card debts, remodel a home with features to assist you age in place (this is a desire of a very high percentage of people; they do not wish to leave their neighborhood, neighbors and familiar surroundings and who can blame them for that), delay starting social security monthly payments until you qualify for the maximum payout (which happens at your age of 70), buy long-term care insurance or pay the tax bill for the ROTH conversion.
Note that I did not mention taking a long vacation or financing someone’s education or a wedding for that matter. The cause for which an important source of revenue/income such as home equity should be used is to be considered very carefully and should be justifiable. Your home’s equity could be the lifeline when you need to avoid drawing from your investments during a market downturn.
We are very hesitant to withdraw from such funds when the markets are down. I have also assumed that when the markets improve, the equity loans could be satisfied with the withdrawals coming from the market funds.
The ultimate way to cash in on the home equity is to sell your home for cash and then downsize or rent the next one. But, as mentioned above, most retirees don’t wish to move.
So, the alternatives are
1) to borrow from your home equity with, of course, home used as collateral
2) refinance an existing mortgage and take cash out
3) borrow with a home equity loan or line of credit or
4) apply for a reverse mortgage.
This is easier said than done, especially for the retirees, because each option comes with opportunities, drawbacks, and costs.
Lenders, when lending a reasonably large amount of money to you, want to make sure that they are getting their money back at the end of the deal and will not end up at the short end of the stick. Even though they cannot discriminate against you based on your age they would ascertain in variety of ways that you have the financial ability to repay the loan you have taken. Most common ways of doing that is by asking for paperwork like account statements, 1099 forms for pension and SSA and a review of your 1040 tax forms for last few years. So, get ready for this kind of inquiry. Lenders always wish to see a 2-year history and at least a 5-year future to satisfy themselves.
Generally, borrowers with higher credit scores and lower “loan to home value” get the best borrowing rates; this relates well to their fear of determining your ability to repay as mentioned above. If we are looking at reverse mortgage, then it works a bit differently because your ability to repay does not come in the picture, but the deal does need underwriting.
No matter how you tap into your home equity, banks and people like attorneys must be involved; you will end up paying many different costs like lender’s origination fee, fees for the third-party services (such as appraisal, title work and recording the lien with the county etc.). These fees can be paid out of pocket or rolled into the loan. There is usually a 3-day cooling-off period (love that terminology) if you decide to back off from the deal.
Most seniors, with home equity to tap into, are good candidates for refinancing. It is so because either home is completely paid off, free and clear or probably their interest rate is high compared to what they could probably get these days. They can either refinance and improve their interest rate considerably or take a new loan and get the cash out of the home equity. The fact that their home may have appreciated in value helps too because now they can borrow even more cash out. Currently the average national fixed rate has hit an all-time low of 2.9 percent for a 30-year mortgage and 2.4 percent for a 15-year mortgage; there could be some mortgage points involved according to Freddie Mac. I should point out, however, that these rates are going up slowly since Federal Reserve has already started tightening their lending rates.
It is always prudent to look at the Tax angle of all these transactions because many rules have changed over the last few years. The cost of tapping your equity may be reduced on your Federal Tax return. If you itemize, interest on up to $750,000 of mortgage or home equity debt (for married filing jointly) is deductible to the extent that the money was used to buy, build or improve your home. If you refinance, take cash out and pay for a car or vacation the interest on that amount cannot be deducted.
The interest accrued on reverse mortgage would not be deductible until you repay the loan which typically happens when the house is sold which is generally when you leave the house for whatever reason.
Mo Vidwans is an independent, board certified financial planner. For details visit www.vidwansfinancial.com, call 984-888-0355 or write to [email protected].
