Ask an Advisor: Is Home Equity an Asset Class for Retirement? More Than 50% of My Net Worth Is Tied Up in My Home

I’ve been hearing more and more about using home equity as an asset class for retirement planning. It now makes up more than 50% of my net worth, with no mortgage remaining. Please share your thoughts or strategies.

– David

Home equity can absolutely be an asset class to consider in your retirement plan. There are several ways to use it, but it’s important to make sure you understand the implications and are comfortable with the tradeoffs. Unlike liquid savings, tapping home equity involves unique financial, tax and personal considerations.

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Ways to Use Home Equity in Retirement

There are several ways to use home equity in retirement, ideally as part of a coordinated strategy rather than in isolation. Some are quite simple, while others are more complex.

Downsizing

If you’re still living in the home where you raised your family, you may find you now have more space than you need. Downsizing is a simple way to tap home equity. You can pocket the difference between what you get from selling and what you pay for a smaller home. The biggest downside to this option for many is the strong desire to stay in their current home.

In addition, selling your primary residence may qualify for capital gains exemptions, allowing up to $250,000 in gains for individuals or $500,000 for married couples filing jointly to be excluded from taxable income.

Sell/Lease

If you can find a willing buyer to agree to the arrangement, you may be able to sell your home with an agreement to continue living there with a long-term rental agreement. While you can remain in the home, giving up ownership may carry an emotional cost. Also, you won’t be able to leave it to heirs (unless, of course, that’s who you sold it to).

Cash Out Refinance

Taking out a new mortgage on your home will provide you with a lump sum of cash that you can use however you like. You’ll need to include the payments in your budget, and your estate or heirs will need to settle any remaining balance or sell the home when you pass. However, you get to retain ownership and remain in the home while accessing the equity you’ve built.

HELOC

A home equity line of credit is a revolving loan that allows you to borrow against your home equity. After an initial draw period, you must begin making payments on the amount you borrow. These may be better for short-term uses. For example, like weathering a downturn so you can avoid taking withdrawals while your portfolio is down. However, it’s important to consider how repayment will affect your cash flow later.

Reverse Mortgage

Reverse mortgages allow you to withdraw the equity in your home while retaining ownership and continuing to live there. You aren’t required to repay the borrowed funds until you leave the property, sell it or pass away. If any of those events occur the balance becomes due. If you pass away with a reverse mortgage balance, your heirs must either pay off the loan to keep the home, sell it and keep any amount above the balance or allow the lender to take possession.

Although these can be useful tools, they are complex, so it’s important to fully understand the terms before committing. You must maintain the property, keep it insured and continue to pay the taxes. Failure to do so can result in foreclosure.

(And if you need more help assessing these options, connect with a financial advisor for free and talk it over.)

Psychological Impact of Using Home Equity

Outright home ownership, free of any mortgage or debt obligations, is a very common desire among the retirees and near-retirees whom I speak with. For many, there’s considerable comfort in knowing they don’t owe anyone anything for their home. There’s real value to that feeling.

Although using home equity as a strategic component of your retirement plan can be a smart move, I’d encourage you to consider how much it is worth to you from a psychological standpoint. If the numbers make sense, you may find it perfectly acceptable and not be bothered by it. It’s a personal choice. I’m not trying to convince you to think one way or the other about it, just that it’s something to deliberately consider in your analysis.

(Working with a financial advisor, especially one who holds the Certified Financial Planner™ (CFP®) credential, can help you balance the financial and psychological sides of retirement planning.)

When to Avoid Tapping Home Equity in Retirement

Although home equity can be a valuable tool, there are times it may be better to avoid it. If you already have sufficient income and assets to support your lifestyle, borrowing against your home may add unnecessary complexity and risk. Likewise, if you plan to move in a few years, taking on new debt could reduce your flexibility.

It’s also important to remember that home values can fluctuate, and unexpected maintenance or local market changes can affect how much equity you actually have available. For example, taking out a home equity loan during a housing peak might leave you owing more than the property could sell for if the market declines suddenly.

Using home equity works best when it’s part of a clear and intentional strategy, coordinated with other aspects of your plan, rather than as an emergency source of cash. (And if you need help designing a retirement income strategy that aligns with your needs, consider working with a financial advisor.)

Bottom Line

Home equity can be a valuable asset class in retirement. There are several ways to access it, each with its own pros and cons. Carefully evaluate your options before deciding whether and how to tap into home equity.

Retirement Planning Tips

From asset allocation and portfolio management to Social Security timing strategies and withdrawal planning, a financial advisor can help you prepare for retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Consider aligning your investment with spending “buckets.” Segment assets into near-term (cash and bonds for the first five to seven years of spending), mid-term (balanced allocation) and long-term (stocks for decades of growth). This reduces the chance of selling equities in a downturn.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.