Housing and Retirement

Here's an interesting piece that talks about how many people are counting on home equity as part of their retirement savings. But that plan has run into a very big snag since home values have dropped recently. A summary of the situation:

The recent and unprecedented decline in home prices is forcing many Americans -- especially those who were banking on the inflated value of their home to make up for paltry savings and falling retirement account balances -- to re-evaluate their retirement plans.

And here's why it's a problem:

One recent study showed that home equity represents 21% of the typical pre-retiree's net worth, second only to Social Security at 41%. Another study found one in five retirees and pre-retirees plan to tap their home equity to help fund retirement.

I don't know which I find more disturbing -- that 1/5 of retirement savings is in an asset with declining value or that 41% (a HUGE number) is coming from Social Security. Why do I find these disturbing? For the following reasons:

1. If 21% of retirement funds are in a home's equity, then the retiree must either downsize their home (and keep the difference between selling and purchase price) or get a reverse mortgage in order to have access to any of the home's funds. I like the first option better, but are that many people really planning to downsize when they retire? Seems to me that most people want to keep living in the same home. As such, the home equity isn't really that accessible in retirement.

2. Who knows if Social Security is even going to be around in a couple decades when some of us start approaching retirement. I'm sure not planning on 41% of my retirement coming from it. I'm banking on 0% from SS -- and if I get anything, it will be a bonus.

3. Add the two up and 62% of pre-retirees' net worths are in two shaky sources. This means that the average person has only saved 38% of their retirement needs? Really? If that is true, we're headed for a big retirement crisis -- especially based on what's going on with health care.

Comments

[texashaze]

Using equity is a BAD idea. Let me attest to that. My parents took this same approach and it blew up. They maxed out the equity and when their house payment exceeded their social security and pensions they filed bankruptsy and then faced foreclosure on their home of 40+ years. They didn't disclose anything to me until weeks before foreclosure. Fortunately for them (and unfortunately for me) I stepped in and bought the house. They pay me some money each month but it's still a significant negative cash flow for me.

The thing that amazed me on this is that a bank gave them a mortgage where the montly payment was GREATER than their monthly income. UNBELIEVABLE! This shows you how corrupt the system is.

my 2 cents....

[Mr. ToughMoneyLove]

1. Downsizing is and will be a more popular and necessary retirement planning strategy than you think.

2. This post contains yet another statement that "SS won't be around for me." What on earth are you basing that on? Have you ever heard a politician state publicly that SS should be abolished? Do you think that baby boomers are going to support politicians who vote to abolish SS? Not a chance. The benefits may be means tested but they are not going away. Folks need to drop this urban myth in the dumpster.

[SAHM]

This is very interesting bc I just got off the phone with my father-in-law, who is very down about their current situation. They decided to sell their home of 25 years 3-4 years ago. They had 100% equity and should have been able to get $750K - $900K conservatively speaking. They did make a few bad choices and bought not 1 but 2 houses before selling the original house. They got rid of one house (trying to downsize) after realizing it wasn't right for them. They about broke even on that deal. They found a dream house/property and purchased it a couple years ago. Unfortunately, they have yet to sell their original house. They took out an equity loan on the original house (about 1/3 of the value) to purchase their current home. Right now, they don't think they could sell their old house at what they owe. It is draining them financially. He has stock and it continues to plummet. They were in great shape a few years ago and never dreamed that their house would sit on the market for more than 3 years. Nothing has sold in their neighborhood in almost 2 years because no one seems to be buying in the higher price ranges. Their networth continues to drop almost every day...

My fear is that they will have to move in with us...AHHHHH!

[Kevin]

I don't know about you guys, but I want to live in my paid-off home during retirement, not cash out and live in a dumpy apartment because I haven't saved enough. Wow, it's amazing the lack of common sense some people have in this area.

[Kevin]

I don't know about you guys, but I want to LIVE in my paid-off home during retirement. Not cash it out to live in a dumpy apartment because I haven't prepared or saved adequately. It's amazing the lack of common sense some people have in this area.

[Kiran]

Home equity is important from a retirement standpoint. It throws off a nice divided: a place to live.

Assuming you've paid off your house when you retire. Having a fifth of your life savings kick off the divided of a place to live, ain't bad.

Its equivalent to spending a fifth of your retirement income stream (interest, sales of assets) on rent. Seem appropriate to me.

[Lord]

These are current retirees. It will only be bleaker in the future. SS is designed to replace 42% of income so that is just about right. Plan on it or not it will be there, at least to the extent of 78%, or 33% of income, based on doing nothing. If doing something means ending up with less, I suggest we don't do it.

[rwh]

Kiran:

There is a difference between spending 1/5 of your retirement income stream on housing and your housing representing 1/5 of your net worth.

[LC]

True, that the house provides a place to live, and if you have it paid off, the value shouldn't matter. That was the point of the article. The problem comes when you are depending on that equity as part of your retirement portfolio (in the form of home equity loans or reverse mortgages) while that equity keeps shrinking. That's why you should plan to live on what you have outside of your home equity.

As far as social security, who knows what will happen? But better to be safe and plan for the worst than come up short.

[Jim]

I looked at social security funding recently myself.

SS is fully funded for 3 decades:
http://www.ssa.gov/OACT/TR/TR08/trTOC.html
""Social Security’s combined trust funds are projected to allow full payment of scheduled benefits until they become exhausted in 2041".

And thats with using moderate assumptions on economic trends. If using an optimistic projection where the economy does well then SS would be funded indefinitely under current projections. Or they could raise taxes a bit. A 1-2% diffesrence in GDP growth or a 1% tax increase would make the difference to keep it fully funded indefinitely.

And even if it did exhaust hit the 2041 date as they're currently predicting then that would simply mean they would run a deficit. Our government hasn't been shy at all about running in a deficit. I really doubt funding SS would take a back seat to other spending cuts.

Back in 1997 they thought the funds would last to 2029. So they've obviously revised the date signification outward and may very well do so again.

Jim

[Jim]

Having 20% or so of your net worth in home equity itself surely isn't a bad thing. Its pretty normal for someone near retirement to have a decent amount of home equity and so its natural for home equity to make up a decent % of total net worth.

The bad thing the article mentions is : "Another study found one in five retirees and pre-retirees plan to tap their home equity to help fund retirement." plus the plummeting home values. If someone has been planning on tapping into home equity for their retirement and their home value drops then that's going to hurt their retirement plans.

Jim

[MrAtoZ]

Reverse mortgages are nothing more than a way for seniors to tap home equity if fixed incomes are not keeping up with costs of living. Are RM's bad debt, like negative amortization mortgages? It's not really debt if it's tapping into real equity.
It will be interesting to see after the fallout from the credit market, and the fallout from the stock market swoon, how popular RMs become in the future.

[Dee]

I don't understand why downsizing is seen as an unviable option for retirement. Everyone does it in my country. You buy a big four bedroom place to raise your family, and then your family grows up and you don't need it anymore, and you probably don't have the ability to maintain it either. Then you sell it, put half of the money into funding retirement, and spend the other half on a two bedroom, low-maintenance townhouse in a retirement village, some of which are quite luxurious. What's the problem here?

[Kevin]

Dee - the problem is most people may trade down in size, but they see those nice new villas with granite countertops, stainless appliances, etc. and they end up trading to an equally expensive home.

[poor boomer]

As a poor boomer with 0 saved for retirement, I predict things are going to get extremely ugly in coming years for poor people when they can no longer work.

[kitty]

I think you are forgetting, as some poster noticed, that these 21% is likely to represent the full value of a paid off home. It may not be always the case but unless you have all the details, this number by itself doesn't mean much. An average house is worth probably over 200K. Do you consider someone for whom 200K is 21% of their net worth broke?

Most retirees didn't just buy a house 2 years ago. It's very likely the house is paid off. So how big a part would you expect a paid off house to be? In my area the median house price is 650K, even now. Do you think someone whose net worth is 5 times as much is poor? Keep in mind that in mid-90s the same home was selling for less than half of this amount.

What is the average price of a house in the US? Around 200K? If so, then the person must have 800K in remaining assets? Maybe some of us wouldn't consider it enough, but a current retiree with 800K isn't exactly broke.

Regarding downsizing. As bee said, it is a perfectly normal thing to do in retirement. You get older, your kids leave home, you don't need or want or find it difficult to maintain the house and cut grass, so you move. At some point climbing the stairs may become difficult. You may move to a smaller and cheaper place or, if you can afford, you can buy a luxurious condo in a retirement community. Some of them may cost as much as your house, in which case it might not matter if property values declined - as they declined in both places.

I do agree that tapping into equity is bad - you risk losing your home. On the other hand, I can see how a reverse mortgage can be a viable option, especially for someone who is single and has no kids. Why leave your home to strangers when you can use the money?

[Double Journey]

Totally believe the statistic because I've had conversations with people who really do believe they will be able to retire off the equity in their home. I tried to point out exactly what you did, that you have to live somewhere and unless you downsize, rising home equity does nothing for you. But alas, it fell on deaf ears.

[Jake]

" If 21% of retirement funds are in a home's equity, then the retiree must either downsize their home (and keep the difference between selling and purchase price) or get a reverse mortgage in order to have access to any of the home's funds."

Those are not the only ways to get funds from home equity. Home equity pays a monthly dividend!

Anybody who currently pays >21% of their gross income on housing expense (either rent or P&I) would love for 21% of their retirement net worth to be "tied up" in home ownership sans mortgage.

[Little Cheese]

Kevin sounds like a housing hoarder. Millions of one- and two-person households live cheaply in houses far larger than they need, while other millions of Americans pay dearly for cramped and crowded housing.