Reverse mortgage, downsizing or HELOC? The best way to boost your retirement income
They say home equity is a form of long-term forced savings. After all, while your bank will be pretty unimpressed if you skip a mortgage payment, no one will really notice if you stop your RRSP transfers.
Add to that the fact that home prices have soared in many parts of Canada over the last decade, and it’s easy to see how many baby boomers have most of their wealth tied up in their house.
However while houses can be great as a way of storing value, they are rather clunky when it comes to converting that value into actual money you can use in retirement.
Put simply, there is no obvious and straightforward way to squeeze cash out of your home.
Still, there are a few options to do that. Global News spoke to financial experts about the pros and cons of each of them.
Perhaps the most obvious way to free up some of the cash tied up in your home is to sell the house and buy a smaller, cheaper place.
Ideally, the transaction will net you a significant amount of money, which you’ll then add to your retirement investments, drawing from the pile gradually as you age.
“It’s the cleanest option, financially,” said Jason Heath, managing director at Thornhill, Ont.-based Objective Financial Partners, a fee-only financial planning firm.
On the one hand, you’ve turned part of your home equity into cash you can actually use. On the other hand, you still get to live in a home of your own, which will probably appreciate in value through the year, a capital gain that isn’t subject to tax, said Rona Birenbaum, a certified financial planner and CEO of Viviplan and Caring for Clients.
Sometimes, though, the problem is where you downsize to. “People overestimate the amount of cash they can free up,” she told Global News.
That’s because real estate transaction costs add up quickly. For example, selling a $1-million home and buying a $600,000 condo in Toronto, for example, will cost you around $78,000 once you account for real estate commissions, the land transfer tax, legal fees, moving costs and other miscellaneous expenses, estimates Robert McLister, founder of RateSpy.com and mortgage planner at intelliMortgage.com.
And in hot housing markets like Toronto and Vancouver, recent trends in the real estate market aren’t generally working out in favour of retiring boomers, with the value of larger, detached homes stagnating and condo prices skyrocketing.
In general, bearing the inherent costs of downsizing makes more sense if you’re planning to stay put in your smaller place for at least 10 years, Birenbaum said.
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If you think you have less than 10 years before you’ll want to – or have to – move into a retirement home, then renting might make more sense.
Not having to buy a house will save you a lot of the transaction costs of downsizing, but you’ll be giving up the security of owning your home. The landlord, after all, can decide to sell or move in at any time.
And while packing your belongings and moving to a new place may not seem like a big deal in your 20s, doing so in your 70s or 80s is a whole other ball game, both Birenbaum and Heath noted.
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A home-equity line of credit (HELOC)
Selling your home seems to be the best way to turn your real estate into cash from a financial point of view, but in practice there are often “a lot of emotional and psychological impediments to it,” Heath said. Put another way, when you’re older you may not think much of leaving the home where you built a life.
According to a recent survey, as many as nine in 10 older Canadian homeowners plan on staying put in their retirement years.
If that is – or will be – you, one option to turn home equity into money is a home-equity line of credit, or HELOC.
Borrowing with a HELOC has a number of advantages, according to RateSpy’s McLister. These include:
- Lines of credit work like credit cards, meaning that you only borrow what you need.
- HELOCs are a relatively cheap way to borrow, with interest rates currently hovering around 4.2 per cent.
- With a HELOC, you can make interest-only payments (for instance, around $350 monthly on every $100,000 borrowed at today’s HELOC rates).
Another nice feature of HELOCs is that, unlike a mortgage, you can repay your balance at any time without penalty, Birenbaum noted. Another option is to settle the debt when you sell the house.
One of the downsides of home equity lines, however, is that borrowers in or approaching retirement have a hard time qualifying for them, McLister, Birenbaum and Heath all warned.
Heath recalled the case of a couple in their 70s with $3 million worth of house and cottage who could not get a HELOC.
“Banks are very unlikely to lend money to people who aren’t working or will be retiring soon,” he said.
One way to get around that is to have a HELOC already in place five or 10 years before you plan to retire, he added.
Another thing to keep in mind is that HELOCs have variable rates. A lot can happen to interest rates in the five to 10 years prior to your retirement or over the course of your post-work life.
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A reverse mortgage
Another option to juice your home equity without leaving your house is a reverse mortgage. That’s a loan backed by your home that you don’t have to repay until you move out or pass away. Both interest and principal come out of your home equity, and the bank makes its money back when the house is sold. You can opt for a lump-sum loan or get a certain amount of cash at regular intervals.
While similar to a HELOC, a reverse mortgage has several downsides compared to a line of credit, McLister and Birenbaum noted. For one, you must commit to borrowing a certain amount of money, which poses the risk of over-borrowing.
But more importantly, reverse mortgages are significantly more expensive than HELOCs, with the interest on a five-year fixed rate currently sitting at 6.59 per cent for HomeEquity Bank and 6.49 per cent for Equitable Bank, the two main lenders offering this type of loan in Canada . Although you can only borrow up to 40 per cent or 55 per cent of the value of your home (depending on the lender), your home equity can erode quite quickly with a reverse mortgage, Birenbaum noted.
(On the other hand, if the value of your home goes up, so will your equity share, which will soften the impact of a reverse mortgage.)
One upside of reverse mortgages compared to HELOCs, though, is that they are meant specifically for borrowers aged 55 and over. Qualifying for a reverse mortgage is much easier for people in or close to retirement.
As for how a reverse mortgage compares to downsizing, let’s go back to the $322,000 you’d net by selling a $1-million home and buying a $600,000 condo in Toronto. As mentioned, the transaction costs would be about $78,000. With a fixed-rate loan at HomeEquity Bank’s current 6.59 per cent rate, that’s roughly the amount you’d pay in interest over five years in order to borrow $200,000, according to the bank’s online calculator.
Of course, your home equity gains would be larger if you opted to stay put and get a reverse mortgage. Even a moderate two per cent rate of appreciation would increase your equity in a $1-million home by over $100,000 over five years. By comparison, your equity in a $600,000 condo would rise by around $62,000 over the same period, McLister calculates.
Still, your reverse mortgage would roll into another loan on which you’d have to keep paying interest at the end of the five-year term, unless you die or sell the house.
Birenbaum, McLister and Heath all described reverse mortgages as a last resort. They can be useful, but mainly for house-rich and cash-poor retirees with few other options.
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