No one can work forever, even if they will. This is why proper planning for retirement is essential. Unfortunately, after assessment, many people discover they do not have enough savings for retirement.
Over 40 percent of Americans dread retirement more than death or poor health. Meanwhile, the number of homeowners has consecutively increased over the last decade.
The increase in home value over this period has made home equity an attractive option to fund retirement. One of the ways homeowners can leverage their home equity to achieve their dream retirement lifestyle is by getting a reverse mortgage.
Before you start asking “how a reverse mortgage works,” there are certain things to consider before deciding whether to fund your retirement with home equity.
Home Value
The major reason that makes home equity an attractive option for funding retirement is home value.
Home equity is the percentage of the home value you own. Except you purchased your home with savings, your home equity is determined by the amount of the mortgage you have repaid so far.
For example, a homeowner who took a mortgage to purchase a property of $500,000 with $100,000 money down will have 20 per cent equity. The home equity will increase as the mortgage is repaid.
Most lenders will allow you to borrow 80 to 85 per cent of your home equity. Hence, if you have low home equity, the eligible loan might be insufficient to help fund your retirement.
How to determine home value
- Using online valuation tools: Some lenders or real estate marketplaces provide online valuation tools for estimating home values. These tools use public records such as property transfers, tax assessments, deeds of ownership, and mathematical modelling to predict your home value in real-time.
- Getting a comparative market analysis: You can request the service of a local real estate for a comparative market analysis (CMA). The CMA will provide an estimated value based on the agent’s market knowledge.
- Personal evaluation: Check real estate listings for similar homes in your area. Compare their prices and deduce an average to estimate your current home value.
Accessible loan options
There are different loan options available for homeowners. The eligibility for these loans varies. While some require good credit scores and health status, others are more flexible. The interest rate also varies.
Some of the loan options you can get using home equity include:
Cash-out refinancing
A cash-out refinance allows you to use some of your home equity to get a new mortgage, usually larger than the existing one. The new loan is first used to settle your existing mortgage while the extra cash is paid to you in cash.
The lender treats the loan as fresh, and you will be required to pay closing costs, typically between 2 to 6 per cent of the new loan amount. The monthly payment will also be higher, and since your home is the collateral, you are at risk of foreclosure if you default.
Home equity loan
A home equity loan is also known as a second mortgage. It is a separate loan from the existing mortgage and typically has higher interest rates than cash-out refinancing.
Lenders typically allow you to borrow up to 85 per cent of your home equity.
Home equity line of credit
A home equity line of credit (HELOC) is not offered as a lump sum payout. You can access the loan whenever you want during the draw period.
The HELOC draw period is the first stage of the loan, during which you can borrow money up to a certain limit. Depending on the lender, it typically lasts five to ten years or longer.
You do not have to repay the loan during this period, but if you do, the credit limit will be readjusted to reflect the repaid loan.
Nevertheless, repayment begins once the draw period ends. You cannot cash out any additional loan until all repayment is completed and another loan is approved.
Reverse mortgage
A reverse mortgage is specifically designed for retirees as it can only be accessed by citizens at least 62.
Repayment will only be requested when the borrower no longer lives in the home, probably due to death.
It is essential to note that interest and fees are added to the loan balance each month, and the balance grows. Your heir may have to repay the loan to inherit the home or allow the lender to sell it to recover their loan.
Retirement plan
Your retirement plan will significantly influence how much you need to retire comfortably.
Focus most on your basic needs when planning retirement. For instance, if your savings cannot afford an expensive trip during retirement, you may adjust the plan and instead visit a more affordable destination with a similar experience.
Loans are recommended if you need them for necessary expenses such as home repairs and healthcare. It is best to have a peaceful retirement without fearing loan repayment.
Plan for beneficiaries
Borrowing money with your home equity means the home is collateral for the loan. You should reconsider if you intend to will the home to your heirs.
Alternatively, you could make your loan amount minimal, provided it will be enough to fund your retirement. This will make it easier for them to repay upon your demise.
Ensure you discuss the loan with your heirs so they can prepare for possible future developments.
