Many consumers may not realize that their home can play an important role when it comes to planning for a secure retirement. In the USA, home equity is one of the most critical creators of wealth for retirees, constituting one of the largest chunks of one’s personal financial assets. When people buy a home, especially their first, they rarely think of it as an investment in retirement, yet it sometimes becomes just that.
Making retirement security a reality
Home equity can be a very effective means to securing retirement, as it can be monetized to meet one’s financing requirement in a number of ways. First, retirees can sell and then purchase a smaller or lower-value home. This has several advantages; including allowing retirees to free up a portion of home equity and/or prune home maintenance costs. Second, retirees can consider a reverse mortgage, which allows homeowners who are 62 years or older to retain their home and convert a part of their home equity into cash. The advantage of a reverse mortgage is that the homeowner needn’t repay the loan until the house is sold. Third, home equity can also be used to secure additional lines of credit or refinance an existing mortgage.
Yet, surprisingly, home equity is not the preferred source when it comes to financing retirement needs. According to the Deloitte Center for Financial Services retirement survey, less than 17 percent of respondents plan to finance some of their retirement needs with their home equity. The number inches up marginally to 19 percent if respondents engage a financial advisor. Further, 55 percent of respondents who do plan to use home equity for financing their retirement needs expect to meet less than a quarter of those needs with their home equity.
What could be the reasons for the lower preference for using home equity for retirement financing?
There can be several factors. Individuals may be resistant to downsizing their homes due to emotional attachments. Other reasons could be a potential lack of awareness about different ways to leverage home equity or complexity associated with monetizing. Specifically, individuals tend to find the terms of reverse mortgages to be complex.
That being said, a potential decline in home prices could be a significant deterrent as it directly impacts home equity values. For instance, the price decline during and after the 2008 financial crisis washed out home equity values. This in turn negatively affected home ownership and the retirement plans of older age groups.
What can financial services firms do to increase the acceptance of home equity as a retirement asset?
Financial services firms can empower clients through education. Financial advisors can focus on increasing awareness about the benefits of home equity as a source of retirement financing. Banks can educate individuals about the terms, conditions, and processes related to reverse mortgages and home equity loans to help overcome complexity issues.
As a longer-term solution, financial services firms can guide clients to hedge against a potential drop in home equity values. One such option is a home equity protection plan, which essentially insures the policyholder against a drop in home values. Home equity protection plans remain underused despite their availability since 2002, perhaps due to individuals’ preferring not to buy such insurance in a rising home price environment. However, clients are likely to be more interested now, having witnessed the substantial and protracted decline in home prices during and after the 2008 financial crisis.
The bottom line is that buying a home is perhaps not only the biggest investment most individuals will make in their lifetimes, but it could also be the ticket to a more secure retirement if they play their cards right. Such a best-case scenario gives new meaning to the old adage, “there’s no place like home.”