Home Is Where The Nest Egg Is

Dramatic drop in home
values will crimp some home
owners' retirement plans

By Robert Powell, MarketWatch
Last update: 10:07 p.m. EDT Sept. 17, 2008


BOSTON (MarketWatch) -- Home, for millions of Americans, is not only where the heart is. It's increasingly where the retirement account is, too. Yes, home equity, along with IRAs, 401(k)s and Social Security is viewed as one of the most important sources of retirement income to millions of homeowners.

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.

Now, however, 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.

To be fair, Americans were told, as home prices rose 60% between 2000 and 2007, not to rely too heavily on their home equity for retirement.

Fidelity's now-defunct Retirement Research Institute, the Securities Industry and Financial Markets Association, and the Center for Retirement Research at Boston College all warned that what goes up usually comes down.

But no one wants to hear "I told you so" now. Instead, they want to know what the decline in their home's value means for them now. Here's what Principal Financial and others think you should consider.

Pay down your mortgage before you retire

Time was when many Americans retired debt free or, if not debt free, certainly without a mortgage. That's no longer the case. The average debt per household increased 45% to $58,700 in 2005, from $40,600 in 1995, with the largest increases occurring among older Americans according to a just-released Principal Financial white paper.

Not surprisingly, that increased debt level is leading to more and more bankruptcies among older Americans. In fact, the rate of bankruptcy filings among those aged 65 and older has more than doubled since 1991, and the average age for filing bankruptcy has increased, according to a recent AARP research report.

To be sure, not every person who retires with a mortgage will declare bankruptcy or eat cat food in retirement. And, to be fair, four in five homeowners in one study said they don't plan to tap the equity in their home as a source of retirement income.

But when push comes to shove and homeowners are faced with the possibility of lowering their standard of living or tapping the equity in their home, it's likely their house will look more and more like a bank account.

Boston College's Center for Retirement Research noted in a recent study that one in three pre-retirees who extracted the equity in their home during the 2000-2007 housing boom and "consumed" all of that money are likely to be worse off in retirement than those who didn't take on more debt to fund a false standard of living.

What's more, retiring with debt leaves little, if any, margin for error. A catastrophic illness or an unexpected home repair while living on a fixed income would leave retirees with few options to raise money, short of selling their home or declaring bankruptcy.

For its part, Principal says those who own long-term care and other types of insurance reduce the risk of uninsured medical expenses and the possibility of selling a house to raise cash.

Get answers

Past performance is no guarantee of future results, but housing will recover at some point.

Trouble is, no one knows when or by how much. According to Principal, the current home price decline came after a 14-year cycle of rising prices -- the longest continuous housing price increase since World War II.

Yes, no one really knows how long it will take for the housing market to recover. Some say it will take four to eight years while others say 12 to 18 months. Regardless of the time, don't bank on the equity in your home to pay for some of your retirement expenses as you did during the housing boom.

Rather than hide under a rock, would-be retirees and retirees need to ask whether and how the decline in their housing wealth affects their retirement plans.

Principal, in its white paper, offers 17 questions financial advisers should ask their clients. You can ask them of yourself in the absence of an adviser.

They include:

Have you estimated how much your house has depreciated within the past two years?
If so, how much has it declined?
How much did housing equity contribute to your retirement plan?
Will this housing price decline affect your planned retirement date?
If so, how many more years do you plan to work?
As a result of this decline, are you postponing any major medical treatment?

Don't forget that a changing marketplace may mean fewer options are available to you. Reverse mortgages became an increasingly popular way for some older Americans to age in place while tapping part of the equity in their homes.

With a reverse mortgage, homeowners who are 62 or older get a loan (typically a line of credit) against the equity in their home. The loan amounts, at least those based on the National Housing Act of 1987, range from $200,000 to $362,000, according to Principal.

But the recent downturn in the housing market will likely reduce the amount of reverse mortgage loans in the future.

(However, the effect of the FHA Modernization Bill, which is part of the overall Housing Rescue Bill, passed this summer, has changed the old county-by-county maximum FHA loans. Now, the new maximum FHA Reverse Mortgage loan of $417,000, will be nationwide.

And, there will be a high-cost area maximum FHA Reverse Mortgage loan up to $625,000. At a minimum the nationwide $417,000 limit was mandated by Congress to go into effect October 1, 2008. The high-cost $625,000 maximum may not be in effect until January 1, 2009. Of course, the more your home has decreased in value, the less equity you will have to tap in obtaining a reverse mortgage; but the higher maximum will be welcome. GB)

More changes ahead?

With changes in the homeowner's health or the death of a spouse, all bets are off. "Declines in an owner's health status, including a nursing home stay or a decrease in mobility, are good predictors of a future house sale," the Principal report stated.

And, if home equity starts to represent a smaller and smaller percentage of a person's net worth, it only stands to reason that any decrease in home prices will result in smaller and smaller bequests.



Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.
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