I hear it from clients all the time, â€œMy house is my best investment for retirement.â€ Unfortunately your â€œinvestmentâ€ is also the place you live and therefore is not really an investment. Donâ€™t get me wrong, there are a lot of smart financial reasons to own a home, but donâ€™t fool yourself into thinking that your home will also provide for your retirement. Itâ€™s a great feeling to have equity in your house but unless you have a hankering to live on the street, it will be much harder to utilize that equity in retirement than you think.Borrowing against the equity is not really an option. For example, assume youâ€™re 65, and you live in a house you paid $50,000 for many years ago that is now worth $1 million. Letâ€™s further assume that you only have a $100,000 mortgage so your actual equity in the house is a whopping $900,000. Itâ€™s tempting to think of that $900,000 as your retirement nest egg, the problem is you need to get access to that equity in order to be able to spend it. Sure you can borrow but since youâ€™re retired youâ€™ll need to make payments on the loan from the proceeds you borrowed. A $500,000 loan at 6% (if you could even get it) would require payments in excess of $36,000 every year. If you only spent half the $500,000 for retirement and set the other half aside to make your loan payments, your reserve to make loan payments would be gone in less than 7 years, leaving you with another 23 years of payments to make.
Taking out a reverse mortgage might work but itâ€™s really only viable if you are well over 70 and plan to stay in your house for a long time. Even then, the amount youâ€™ll get to live on will be likely be less than you think. Based on the current reverse mortgage market, our 65 year old in the example above would only get about $1,200 per month. While thatâ€™s not bad, if his $900,000 of equity were invested in a safe, bank CD at 5% heâ€™d get $3,750 a month instead!
So what happens if you sell the house and invest the proceeds? If our homeowner sells his house for $1 million, after commissions, taxes and paying off the mortgage, heâ€™s likely to be left with about $700,000â€¦..and no place to live. Unless he is prepared to downgrade his lifestyle pretty substantially, our now, former homeowner will need to pay at least $2,000 in rent each month, maybe more. If he invests his $700,000 wisely he might get a 10% return. Unfortunately, that income is taxable and since he no longer enjoys the tax deductions he once got with his house, he is probably looking at closer to a 7% after tax return, or about $4,000 a month. After paying his rent heâ€™s left with only $2,000 a month, and probably less over time as his rent increases. While still better than nothing, itâ€™s probably far less than what he thought heâ€™d enjoy in the context of his $900,000 in home equity.
If he wants to maintain his lifestyle, itâ€™s going to be hard to do unless he keeps the house and only sells it when he can physically no longer live there. At that point the equity can be used to support the assisted living or nursing care heâ€™ll likely need in his final years. That wonâ€™t do him much good now since heâ€™s only 65. If heâ€™s willing to downgrade his lifestyle then the scenario that does make sense is he sells his house and uses the $700,000 to buy another, less expensive house. If he moves further out of town or relocates he may be able to live happily in a $500,000 house and invest the remaining money to cover taxes and maintenance. He now lives pretty much for free and doesnâ€™t deplete his resources by paying off a loan or renting.
The important point is that in all these scenarios our homeowner would be in serious financial trouble if he retired without real retirement savings beyond the equity in his house. Donâ€™t delude yourself into thinking that your house will provide for your retirement. Regardless of how well youâ€™ve done on your house you still need to save as much as you can for retirement. Having a lot of equity in your home can give you some valuable options later in life but it wonâ€™t necessarily pay for your expenses. Remember, you canâ€™t eat your house no matter how tasty having all that equity may seem.