Home values like trees don’t grow to the sky and bubbles will burst.
Since the Great Recession (2008 – 2013) many areas in Massachusetts, especially the Greater Boston area and surrounding communities, have experienced extraordinary increases in home values. Fueled by the upsurge in economic recovery, low interest rates, and a scarcity of homes for sale, housing prices have spiked in many areas to near and record highs.
How long this trend will continue is unknown, but one thing is certain – sooner or later prices will peak and decline as economic and business cycles change and unforeseen events occur. Currently, however, there is opportunity for senior homeowners to lock in these gains and increase retirement resources.
HOUSING WEALTH – NEW TOOL FOR RETIREMENT PLANNING
Astute financial planners and advisors are upgrading retirement plans to include housing wealth in the financial planning process. Housing wealth (accumulated home equity) historically has not played a significant role in traditional financial planning. However, new studies conclusively demonstrate its value mitigating two growing retirement issues: (1) longevity risk – running out of money; and (2) sequence of return risk – erosion of financial assets in down market cycles. Today, unfortunately, these professionals are a minority, but ongoing research and professional education is bringing enlightenment and change.
Retirement researchers including the Boston College Center for Retirement Research along with distinguished academics and retirement industry experts conclude: the utilization of accumulated home equity must become a fundamental consideration in the financial planning process. Effectively, home equity management can facilitate achieving three objectives: (1) improve cash flow and liquidity; (2) protect assets under management, and; (3) reduce or eliminate longevity and other retirement risks.
OPPORTUNITY FOR FINANCIAL PLANNERS
According to the Boston College Center for Retirement Research analysist, Stephen A. Saas, home equity is the most underutilized asset in retirement financial planning. In an academic brief published in March 2017, Sass explains the foundational issues why it is not commonly used, and advises that downsizing and/or a reverse mortgage provide optimal solutions for making better use of home equity for retirement security. The brief’s key findings are:
- Home equity, the largest asset for most households entering retirement, and can be best used by downsizing or by taking out a reverse mortgage.
- Few households currently use either option due to: (a) behavioral and informational barriers; (b) preference to stay in one’s home; and, (c) high transaction costs.
- Behavioral and informational barriers are the primary causes that impede downsizing or using a reverse mortgage.
- An open question is whether more retirees will overcome those impediments and tap home equity in response to growing financial pressures.
HOUSING WEALTH MANAGEMENT STRATEGIES
Managing housing wealth requires careful consideration of each client’s circumstances, preferences and objectives, including: (a) financial, (b) estate/legal, (c) life style, (d) long term care, and (e) legacy considerations.
Primary strategies include:
- Sale of the home. Most commonly done to downsize, eliminate debt, increase liquidity and cash flow, move to a new area or property type, and fund divorce or separation agreements.
- Reverse Mortgage. For those who do not want to sell. The Home Equity Conversion Mortgage (HECM) is the HUD/FHA insured reverse mortgage. HECMs are designed for senior homeowners (62 or older), and provide unique features that enhance and extend retirement security, including:
- A guaranteed and growing line of credit (not affected if future property value declines).
- No effect on Social Security or Medicare benefits
- Withdrawals are not taxable as income
- Optional payment obligations – monthly payments are not required, but may be made in any amount, as desired without penalty. Further, the undrawn credit line amount is simultaneously increased dollar for dollar when the balance owed is reduced by voluntary payments.
- No maturity date – loan repayment due only when no borrower resides in the property.
- Non-recourse loan – neither borrowers nor heirs incur personal liability.
- Loan can never be called, or the credit line cancelled, as long as the loan agreement remains in good standing – property tax and insurance obligations are kept current, basic maintenance is performed, and at least one borrower resides in the home.
- Loan repayment obligation can never exceed property value at the time of sale or repayment. FHA insurance protects both lender and borrower if a value deficiency occurs at time of repayment.
- Traditional home mortgage term loan or Home Equity Line of Credit (HELOC)
- Most suitable for short term needs.
- HELOCs generally available at lower cost and easier to obtain.
- Credit line available for a limited time, usually ten years.
- Monthly payments required – commonly interest only, then increased to fully amortize repayment when the initial period ends.
- Borrowers must meet lender financial and credit qualification requirements.
- Sale lease-back. Sale of the property to generate liquidity and payoff mortgages or liens with a corresponding agreement to rent or lease the home for a specified term.
- Life Estate. Partial sale of the property reserving a life estate usually to a relative or prospective heir. The sale may include payment of consideration, or not – most commonly done for estate and/or Medicaid planning.
- Home sharing. Renting excess space to a boarder(s), or participating in new home sharing services like Airbnb to generate income.
- Real Estate Equity Option Agreement. Not a loan – an agreement to share a portion (typically 15% to 50%) of future property value increase (or decrease) from the current value in consideration for upfront cash payment. This is not debt and no monthly or interim payments are required. Funding is provided by private (institutional) investors. This program is currently available in Massachusetts and a limited number of other states.
A RETIREMENT RESOURCE – HIDING IN PLAIN SIGHT
Thanks to the considerable and ongoing efforts the retirement researchers and academics are providing, housing wealth is now being recognized as a vital component to more effective retirement planning. This enlightenment is stimulating new thinking and insights into the various applications housing wealth can provide, and offsetting old-school thinking that did not actively engage the largest asset most consumers have.