‘We have no children or heirs, and have no one to leave our estate to other than charitable causes’

Dear Big Move,

We’re a couple set to retire early in the next few years. We are in our mid-50s. 

We will have about $2 million in assets by then, which includes $500,000 of savings and taxable funds to live on until we can tap our retirement funds.

Our home is worth an additional $900,000, and we are staying put for life. We have no children or heirs, and have no one to leave our estate to other than charitable causes.

How might we leverage our home to generate some additional “free income” in retirement? What are the best ways to do this? Any pitfalls to avoid or ways to protect ourselves?

We don’t necessarily need the money, but if we can generate a basically free annuity stream while we live in our house, why not do so?

Dear Ready,

Congrats on building a significant amount of savings for your soon-to-come early retirement. 

Saving up $2 million and buying a home that is now worth $900,000 must not have been an easy feat. It’s also exceptionally impressive, given that the median amount that people aged 55 to 64 have saved is about $185,000, according to data from the Federal Reserve’s most recent Survey of Consumer Finances.

While you likely already know what options you have to extract that equity in your home, which you are considering perhaps as a way to build a financial buffer in your retirement, you might be surprised to learn the fees and costs associated with such plans. And for that reason, it

Home-equity line of credit

Two options for that is to look at a home-equity line of credit, and a reverse mortgage:

A HELOC refers to a type of revolving credit that is secured by your home. Think of it as a credit line, like a credit card, that is secured by your house. It’s like a second mortgage that gives you access to cash, based on the value of your house minus the amount you owe on your mortgage (if you still have an outstanding balance). You draw on this line of credit, and repay some or all of it monthly, just like a credit card. You typically have a set period of time to withdraw cash from a HELOC. 

With a HELOC, “you can borrow as much or as little as you need up to your credit limit and pay interest only on what you actually use,” Peter Mallouk, CEO of Overland Park, Kan.-based Creative Planning, an investment advisory services company, told MarketWatch.

The downsides of a HELOC are that rates are relatively high, and they are also variable, which means you could end up with a sharp increase in payments if interest rates were to increase. You might also have to pay upfront costs, warns the Consumer Financial Protection Bureau, such as a property-appraisal fee, or an application fee, or closing costs, and more.

Though there are fees involved, HELOCs “are usually very low cost relative to other borrowing options,” Mallouk said. 

Reverse mortgage

The other option you have is a reverse mortgage. 

Reverse mortgages refer to a type of financial product catered for people aged 62 and over. They turn the equity in your home into income to help you with retirement, according to Rocket Mortgage. Provided you meet the necessary requirements for a reverse mortgage, the lender will make payments to you, which will first go towards paying off an existing mortgage, if there is one, followed by monthly payments or a line of credit. 

“Reverse mortgages are more complex, but there are no monthly payments due unless you sell the house, move out, or pass away and it provides a steady stream of income for your entire life,” Mallouk said. 

One common reverse mortgage is insured by the federal government, which is the home-equity conversion mortgage. The HECM is a type of reverse mortgage and is available to qualifying homeowners who own a single-family home, or any of these types of properties

But beware of the potential pitfalls. “These involve higher fees and complexity,” he added. These fees can include mortgage-insurance premiums, an origination fee, and servicing fees. Additionally, all the money you end up owing gains interest — it is not free money. The interest and fees added to the loan balance each month are repaid when the borrower no longer lives in the home, according to the CFPB. You will also still need to pay property taxes and homeowners’ insurance.

With $2 million in the bank and with just a few more years to go until you start earning Social Security Income, you need to decide if it’s worth going through all the trouble of getting a new mortgage just to extract value in your home. Very few things in life are free, and especially so when it comes to things like financial products.

Instead, what you can do now is to “make sure your portfolio is best positioned to provide you income for as long as possible, keeping in mind Social Security will take some pressure off your income needs in 15 years,” Mallouk said.

And if you anticipate that you need the $900,000 further down the line when your funds run a little thinner, you can always tap on the same levers to extract wealth from your home equity. 

The bonus: The longer you wait to touch it, the more your home’s value will likely increase. For instance, in the last five years in New Jersey, where I live, the median sales price of a single-family home rose 53%, according to local outlet NJ.com, which cited data from the industry group New Jersey Realtors.

Don’t put yourself under too much pressure to retire early — you may, for example, wish to ease into this next phase of your life with part-time work. Whatever you decide, enjoy the fruits of your labor when you make your decision.

Arthi Swamination