In an ideal world, retirees would not need to use home equity to fund their retirement. But, for many people, their homes will be their biggest asset when they retire and they may need to realize some of that equity.
Indeed, more than a third of Canadian retirees say that they expect to use home equity as a source of income in retirement, according to a survey conducted by Toronto-based Fidelity Investments Canada ULC in March of this year.
That option tends to work well when clients choose to downsize their residence rather than using refinancing options. By spending less on their new home, clients can redirect part of the proceeds of the sale to their investment portfolio.
But clients should be wary of taking on home equity loans or reverse mortgages to fund their retirement, notes Kelly Trihey, portfolio manager with Trihey Financial Group Inc. in Montreal. “They’re effectively taking out a loan that, in the worst-case scenario, could leave them without any place to live,” she cautions.
For example, if interest rates rise, clients’ need for retirement income may increase as rates on home-equity loans and reverse mortgages move higher. Clients in this position also could find that the value of their home drops.
Downsizing often makes the most sense for retirees with large homes and no children still living with them. But if the goal is to boost assets to increase cash flow, clients need to net a significant amount to make this worthwhile, says Barbara Garbens, president of B L Garbens Associates Inc. in Toronto. The key word is the “net” amount, which should be calculated after taxes, fees, commissions, legal charges and moving expenses. Garbens believes clients need to net at least $150,000; she says that $50,000 probably doesn’t add enough to future retirement income to make a move worthwhile.
There are other options in using home equity. One is selling the house, putting all the proceeds into an investment portfolio and renting a house or apartment. That reduces maintenance and other expenses that accompany a family home. But this strategy means that your client won’t participate in rising house prices, while rent typically rises annually.
Another option is to sell the home and retire to an existing cottage, says Aurèle Courcelles, assistant vice president, tax and estate planning, with Investors Group Financial Services Inc. in Winnipeg. He says this strategy is common, particularly for snow-birds who live at the cottage in the spring, summer and early autumn, then spend winter in a warmer location.
However, many people prefer to stay in their current home. Indeed, 68% of pre-retirees in the Fidelity survey said they “expect to stay in their own home throughout retirement.” For this group, there are other suggestions.
A popular refinancing choice is a home-equity loan, which is similar to a secured line of credit and requires only that interest be paid monthly and is useful for unexpected or large expenses.
A reverse mortgage may be appropriate for clients with little income and who are content to pay the debt when the house is sold later. This strategy gives access to the home’s equity, either through a lump sum or instalments. Income streams are preserved by adding the interest to the amount owed under the mortgage. But clients should note that the compounding of the interest can make this an expensive option.
Some clients may be comfortable renting part of their home. However, these clients should be wary of tax consequences, such as income taxes on rental income or the loss of the principal residence exemption on portions of the home that are rented.
Clients also may underestimate the cost and inconvenience of becoming a landlord. These burdens can range from expensive renovations to create a self-contained apartment to sharing a kitchen and bathroom.
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