How Home Equity Can Fuel Retirement Income

The illiquidity of home equity can make retirement income planning difficult for those with much of their wealth concentrated in residential real estate.

Art by Suharu Ogawa

Surveys by the Employee Benefit Research Institute (EBRI) show home equity accounts for nearly half of all assets American families will depend on for retirement outside Social Security benefits.

According to EBRI, for all U.S. families with a working head ages 25 to 64, the median percentage of home equity owned plus individual investment account assets owned relative to home equity owned plus net financial assets is 78.2%. Stated more simply, people hold relatively little of their wealth (about 20% on average) outside residential real estate and individual investment accounts, such as 401(k)s or individual retirement accounts.

Notably, this percentage increases significantly with age: From 55.0% of wealth held in home equity and investment accounts for those families with heads ages 25 to 34, to 87.4% for those families with heads ages 55 to 64.

Among retirees with $100,000 or more in assets, nine out of 10 own a primary residence, LIMRA finds, dropping to seven in 10 among retirees with fewer assets. While such figures make it clear that home equity represents a significant portion of the wealth Baby Boomers intend to rely on during their retirement, what is less clear is exactly how they intend to turn such equity into a tax-efficient income stream.

A Traditional Approach

Reverse mortgages make sense for some retirees who wish to remain in their home, who need some additional income and who are not concerned about not leaving the equity in their home to their heirs, says Wade Pfau, professor of retirement income at The American College of Financial Services in Bryn Mawr, Pennsylvania.

Pfau suggests reverse mortgages are likely going to be the most useful for the middle class or the mass affluent. This is because the limit placed on a reverse mortgage loan is currently about $640,000. Furthermore, there are conditions that have to be met before a person or a couple can qualify for a reverse mortgage, adds Steven Klein, mortgage director at AmCap Mortgage in Greenville, South Carolina. At least one of the borrowers has to be 62 or older, and the home being mortgaged must be the primary residence. Finally, the home must be a single family home, or a Federal Housing Authority-approved condominium, townhome or mobile home.

One additional wrinkle is that, if the borrower has an existing balance on their original mortgage, they must use whatever amount is required from the reverse mortgage to pay it off completely, Pfau explains. So for example, “If I still have a $100,000 mortgage, and the reverse mortgage gives me $300,000, I would have to pay that off immediately and be left with $200,000,” he says.

To use a reverse mortgage, the borrower must maintain their property in good order and keep up with their real estate taxes and insurance, notes Tim Hewitt, senior wealth advisor at Wiley Group in Conshohocken, Pennsylvania.

According to the experts, reverse mortgages are often used as a bridge before reaching maximum Social Security claiming age. So, for example, if a 62-year-old wants to retire but wait to collect their Social Security until they are 70 in order to receive the highest possible payment, they might turn to a reverse mortgage and rely on that money in the eight-year interim. Increasingly, reverse mortgage borrowers are also taking out the loans and letting them sit there as a standby line of credit before accessing the money.

A New Approach

In a recent conversation with PLANADVISER, Bill Walker, chief revenue officer at Unison, explained his firm’s new investment-based approach to helping home owners liquidize portions of their home equity.

Walker says his firm’s approach is to provide equity investment backing to individual home buyers, adding this service should be attractive to many financial advisers and their clients. Unlike a home equity loan, homeowners who partner with Unison don’t garner any added debt, monthly payments or interest. Unison is compensated by taking a percentage of the change in value of the home in the future, up or down. In that sense, the investment company wins when its customers win and helps offset the loss to the consumer if the house’s price declines.

“When it comes to serving older people who already own their homes, we think our solution can be very powerful,” Walker says. “By making a cash investment in the home alongside the owner, we can free up the equity that is illiquid in their home. To date, the significant majority of people we have worked with have used the funds for debt consolidation or for doing home improvements, often so that they can age in place.”  

Walker notes that he spends a lot of time explaining that his firm’s new solution is not a debt product and is, in fact, quite distinct from a reverse mortgage.

“Rather than a debt-based approach, we make a cash investment right alongside individuals in their home,” he explains. “We get paid based on the change in value of the home. So, if we have a transaction at $500,000, and the home value goes up to $600,000, we share in the $100,000 up-change in value. It’s not a new approach in the sense that business owners and folks in commercial real estate have long been using equity financing options. This is just a way for the average consumer, if you will, to get the leverage that professional equity investors can bring in.”

Walker says the firm’s typical investment size to date has been about $100,000.

“There is a lot of room in that size transaction to accomplish both debt consolidation and home remodels to age in place,” he notes. “One other use case that has resonated with this older audience is the idea of using the cash influx to purchase an annuity. Most people don’t necessarily have that big cash lump sum on hand to buy an annuity in one go. This could potentially be a great way to turn your house into a revenue stream without some of the downsides of reverse mortgages.”