Leveraging Your Home in Retirement

Even after decades of saving, most retirees find that their home is still their single biggest asset, according to a recent report from the Wharton Pension Research Council. And yet the question of what to do with a primary residence in retirement is often presented as binary: Stay put—or sell?

If you decide to stay in your home, it's generally wise to pay off a mortgage before you retire, which will help establish a strong financial footing later in life. "That gives you a lot more financial freedom," says Chris Kawashima, CFP^®, a senior research analyst at the Schwab Center for Financial Research.

But staying put doesn't mean you can't leverage your home's value in retirement. After paying off your mortgage or building up equity in your home, you may wish to consider renting it out or tapping its equity to support retirement, especially in a hot housing market.

Though such moves can make sense, each carries its own risks. "You may be tempted to treat your home as a bank to support your retirement, but like everything else in life, it pays to plan ahead and weigh all your options," says Rob Williams, managing director of financial planning at the Schwab Center for Financial Research.

Here are the three most common ways to tap a home's value in retirement.

Many retirees choose to relocate or downsize due to climate, cost of living, or for family or health reasons. "Despite the emotional attachment to the family home, more and more retirees may be thinking, We don't want to take care of this house anymore and may no longer need the space—never mind the expenses beyond a mortgage, such as maintenance and property taxes," Rob says. This is especially true of those on a fixed income in high-tax states like California and New York, who were especially hard-hit when the Tax Cuts and Jobs Act of 2017 capped the federal deduction for state and local taxes (SALT) at $10,000 per year.

Before you put your house on the market, however, it's important to understand the potential capital gains tax liabilities. Sellers can exclude the first $250,000 in profit ($500,000 for married couples filing jointly), provided they've owned the house for at least two years and used it as a primary residence for at least two of the past five years.

You can calculate capital gains from a home sale by subtracting your cost basis from the selling price. The cost basis includes not only the price you paid for the house but also certain closing costs and settlement fees, along with the cost of any major capital improvements (as opposed to simple repairs), such as additions, a new roof, and even landscaping. It can also include home insurance reimbursements you received for casualty losses, as well as real estate taxes or other costs you paid on behalf of the seller when you first bought your home. IRS Publication 523 outlines which costs and improvements can and cannot be factored into the cost basis.

"Keeping good records, including receipts, is important if you want to take advantage of the kinds of improvements that can increase your cost basis and hence lower your tax bill," Rob says.

If you don't plan to live in your house, renting it out can provide another source of income while preserving the option of returning to it or eventually passing it along to your heirs.

A rental property can provide not only income but also potential tax benefits. For example, you may be able to deduct certain expenses, such as depreciation and repairs, from your annual rental income. Keep in mind, however, that you'll likely face a host of tax obligations as well—and that any taxable rental income could potentially push you into a higher tax bracket.

"You'll also want to ask yourself, Do I really want to be a landlord? Am I OK with maintaining a rental property and managing a tenant?" Chris says. "Finding a good property manager can help, although it can also eat into your rental income—typically around 10% of the monthly rent."

Also, be sure to check with a real estate agent or your homeowners association regarding local rental laws, which can vary by municipality and even by neighborhood. Owners should also consider setting aside 1% to 2% of the home's value to avoid having to sell securities in a down market to pay for any unexpected expenses.

Finally, Chris urges those planning to rent out a second home to treat it as a separate business entity. "Registering your rental property as a limited liability company (LLC), for example, can help protect your other assets in the event you're sued—as can liability insurance," he says.

Though you can borrow against the value of your home using either a home equity line of credit (HELOC) or a home equity conversion mortgage (HECM), they serve very different purposes.

• A HELOC allows you to borrow against the equity in your existing residence—and the interest (on up to $750,000 in total mortgage debt1) may be deductible if the funds are used to purchase, build, or substantially renovate a primary or secondary residence. "If your goal is to repair or enhance the value of your home before a sale, then a HELOC can be a good option," Chris says. "However, I've seen people use HELOCs to fund ongoing expenses, and that can be a concern. Generally speaking, you're better off living within your means and not using a line of credit to support vacations or other nonessential expenses that don't improve your home." 

• An HECM, which is a type of reverse mortgage, uses the home's equity to offer those 62 and older a fixed monthly payment, a lump sum, or a line of credit that, unlike a standard mortgage, doesn't require regular loan repayments. Instead, accrued interest is added to the balance and the loan doesn't have to be paid off until you move, sell, or pass away.

A reverse mortgage can allow you to hold on to your home while tapping some of its value for interim expenses. Additionally, if you use a Federal Housing Administration (FHA)–insured reverse mortgage, neither you nor your heirs will have to pay back more than the home is worth. On the other hand, it means putting some of your home equity toward the loan's fees and interest payments.

Reverse mortgages can provide flexibility to retirement income strategies. "For example, if you want to avoid tapping your portfolio during a down market or you require emergency cash beyond what you have on hand, a reverse mortgage could be a good fit," Chris says. "What's most important is to be strategic with its use. There's always a cost to borrowing, and reverse mortgages are no different."

The Consumer Financial Protection Bureau recommends you talk first with a federally approved housing counselor who specializes in reverse mortgages to fully understand both your options and the terms of any loan you do undertake. A financial planner can also help you think through the best way to tap your home's equity for your needs.

If you're a retiree with substantial equity in your home, you may be tempted to sell in order to augment your savings, particularly if you're lucky enough to live in a desirable real estate market. But don't lose sight of the fact that your house is also a home with an emotional value.

"Even those who've run the numbers and are selling for all the right reasons can find the decision to leave an emotional one," Rob says. "That's one reason it's important to weigh all your options well in advance, so you choose the decision that not only makes the most financial sense but also is the one with which you're most comfortable."