Home Wealth Can Help Retirees to Fight Inflation
These days, inflation is on the minds of most people — and it is of particular concern for seniors. With prices rising at the fastest pace in decades, many people who are in or nearing retirement have heightened fears that they may outlive their savings.
What Is the Current Rate of Inflation?
By one measure, the January 2022 consumer price index, the cost of consumer goods — e.g., food, housing, and gas — rose on average by 7.5% over the past year. That’s the fastest rise since the early 1980s.
Retirees Face Unique Challenges When Inflation Soars.
Higher wages generally don’t benefit retirees.
When inflation rises rapidly during your peak earning years, the erosion in the buying power of your dollars could be offset by an increase in wages as businesses adjust to the times.
When you are in retirement, your days of working to earn a paycheck are in the past — or, at least, that’s probably where you’d like them to stay. So, when prolonged inflation occurs during your retirement, you may have to explore other resources to combat its effects.
Health care expenses loom large in retirement.
Health care costs are rising, and retirees generally have more health care needs and less budget wiggle room than the general population. While there are some things retirees can scale back on, other things like going to see a doctor for medical care are unavoidable, as are their costs.
According a study conducted by The Senior Citizens League (TSCL), about two-thirds of senior households spent nearly a quarter of their Social Security retirement benefits on health care.** While Social Security is one of the few retirement benefits that periodically adjusts for inflation, TSCL also estimates that since 2000, Social Security benefits have lost 30 percent of their buying power.
For seniors on fixed incomes, inflation could be especially tough.
Inflation and a fixed income are typically not a good grouping. The less financial flexibility one has in retirement, the harder it could for him or her to mitigate the impact of inflation.
Seniors don’t have time to wait out prolonged market downturns.
How inflation will affect stock market performance is unknown. But if there were to be a downturn in the market and high inflation, it would make it harder for the average investor to stay ahead of inflation. Older adults have less time to wait on a market rebound.
Investments with set annual returns, like a fixed-rate bond, are not immune to the effects of inflation, because the set payments received each year would be worth less given high inflation.
Many of today’s retirees are not financially prepared for retirement.
People are living longer, which means one’s money must live longer, too. Many of today’s retirees are counting on traditional retirement strategies — e.g., personal savings, 401(k)s, and Social Security — to meet their security needs throughout retirement. But the hard reality for many retirees is that those strategies alone may not be enough, even without factoring in a potentially prolonged period of high inflation.
When a retirement income gap exists, two options retirees can explore to help close that gap is to downgrade their living standards or increase withdrawals from their retirement accounts (which, of course, increases the risk they will outlive their savings).
However, for retirees who own their own home, there is a third — often overlooked or dismissed — option: the strategic use of home equity.
Leveraging Home Equity in Retirement
For many senior homeowners, the largest portion of their net wealth can be found in a familiar place: their own home. Today, senior homeowners in the U.S. are sitting on over $10 trillion in home equity†. While home equity is good, cash can often be better in retirement, as it is something retirees can use now.
Homeowners have several options for accessing their home’s equity. Outside of selling the home, there are home-secured loans designed to release equity from the home while you, as the borrower, continue to live there, including a Home Equity Loan (HEL), a Cash-Out Refinance, and a Home Equity Line of Credit (HELOC).
But senior homeowners may find that the more optimal loan for them to tap home equity is one that’s designed specifically for homeowners aged 62+ and their unique needs. It’s called a Home Equity Conversion Mortgage (HECM), commonly called a reverse mortgage) loan. A distinct advantage of a HECM over other types of equity-release loans is its repayment flexibility, which can help borrowers to increase their monthly cash flow to help meet their security needs in retirement.
How Does a HECM (Reverse Mortgage) Work?
A HECM allows homeowners aged 62+ to convert a portion of the built-up equity they have in their homes into cash (without incurring income tax) and defer repayment for so long as they live in the home and pay the property-related taxes, insurance, and upkeep expenses.
The HECM loan proceeds can be used for just about anything. Options for the borrower to receive the loan proceeds include a single lump sum disbursement; a line of credit to use as needed; and fixed monthly payments (for a set number of months or for the life of the loan).
The HECM loan, like any other type of loan, must be paid back, plus interest and fees. But unlike traditional home equity release loans — for which borrowers must make monthly payments toward the loan balance for the life of the loan — with a HECM, borrowers can choose to pay as much or as little toward the loan balance each month as they wish or make no monthly mortgage payments at all. They just need to pay taxes, insurance, and maintain the home.
This repayment flexibility continues until a maturity event occurs, such as the last surviving borrower permanently moving into a nursing home, which would make the loan due and payable. Since a HECM has a “non-recourse” clause, you (as the borrower) or your heirs will never owe more than the value of your home at the time of loan maturity.††
How a HECM Can Help A Retiree Fight Inflation
Any financial shock — like a period of sustained high inflation, having to foot the bill for in-home care costs, or a reduction in retirement income due to the loss of a spouse — makes it harder for retirees to achieve their financial goals.
The prices of consumer goods aren’t the only things these days that are on the rise. Home values have risen to historic values, which presents an appealing opportunity for seniors who are looking to leverage their home equity in retirement.
Here are just a few examples of how you may be able to use a reverse mortgage:
- Refinance a traditional mortgage and free yourself of the burden of fixed monthly mortgage payments. You would still be responsible for maintaining the home and paying the property-related taxes and insurance.
- Use the loan proceeds to cover the higher prices of consumer goods or pay for in-home care or to renovate your home.
- Use the loan as a tax management tool to receive deductions when needed or to withdraw less from IRAs and other taxable sources.†††
- Use the available line of credit as standby portfolio protection. For instance, you could use a reverse mortgage to enhance your cash flow in economic down times, which could make your investments last longer while net worth will not necessarily decrease.†††
- Use the loan to help you get the most lifetime value from your Social Security benefits
- Use a growing line of credit as a protective hedge against your home’s value — the unused portion of the available line of credit grows at the same rate as the compounding interest rate on the loan balance, giving you access to more funds over time.