Plan B for retirees who counted on home equity


Published: Friday, January 2, 2009 at 7:15 p.m.
Last Modified: Friday, January 2, 2009 at 7:15 p.m.

The safety net is almost gone, the nest egg is cracking.

Many Americans have recently found themselves changing retirement plans after losing a substantial amount of home equity as the housing market and the overall U.S. economy struggle. These folks face years of living on fixed incomes from pensions, 401Ks or IRAs, and Social Security, but don't have the time to recover their losses.

Homeowners who've tapped their home equity, then spent it like yellow-and-blue Monopoly money, find themselves with no more funds to extract. Some have been laid off, relinquished their home in a foreclosure, or lost pensions after their employers' business failed. Ideas of a comfy retirement full of relaxation and travel have been abandoned.

The good news is about 30 percent of homeowners have no mortgage at all. So even though their properties are probably worth less now than a few years ago, these people can tap into that equity cushion if necessary.

The bad news, however, is that about one in six with a mortgage now owe the bank more than their homes are worth, according to Moody's economy.com. Most of these are property owners who purchased their homes within the past few years, or refinanced their properties and siphoned off too much equity.

Knowing that, it's time for Americans to explore other options other than relying on home equity as a fail-safe, especially if they have no other retirement investments or savings. Options include downsizing their home, selling assets, postponing retirement by working longer, and signing up for a reverse mortgage. These decisions require heavy thought because each has its challenges and risks.

Choices have been difficult for Ken King, 61, who once planned to retire in his early to mid-60s. The value of his home has dropped $70,000, so he's scrapped plans to sell the five-bedroom house and downsize, because the savings won't be substantial enough to make it a smart move. He's also seen his 401k lose value.

So, King, a credit counselor in Sheboygan, Wis., says he will likely work into his early 70s to compensate.

"This is something I wouldn't have considered even thinking about 1 years ago," said King, adding that priorities have changed this year among those he counsels.

"A year ago, we were talking to people about what they need to do just to make it," King said. "Now we're talking to people about what they have to do to survive."

King's own strategy of working longer is actually a growing trend. AARP reported in April that almost one in four people from age 45 to 54 planned to delay retirement, with one in five people ages 55 to 64 thinking the same.

Staying on the job has benefits besides a paycheck. Employment is often a requisite in qualifying for mortgage refinancing, a good option for those with equity and good credit because rates have fallen to historic lows. But refinancing becomes almost impossible for seniors on fixed incomes with no job or equity.

The scenario becomes more serious if the senior has stopped working and wants to return to the work force, especially as health issues crop up and competition for jobs increases, said George Moschis, director of the Center for Mature Consumer Studies at Georgia State University.

By working later in life, pre-retirees also can consider putting off collecting Social Security, a strategy that could lead higher monthly payouts once they do start collecting.

Finding a smaller and less expensive home has long been relied upon to bolster retirement budgets. Ideally, profits from the sale of a larger home can be used to buy the smaller home with cash, with no mortgage, and the homeowner can pocket the rest. But the current environment of falling home values and tight credit has made home buying a selling a more difficult proposition in many markets.

Another way to shore up retirement accounts is selling off assets, including cars, second homes, stocks and expensive jewelry. They often have emotional attachments that don't match their resale values.

"Spending was really the norm for (baby boomers), buying and having, becoming more materialistic than previous generations," Moschis said of the more than 75 million baby boomers who are approaching or have reached retirement age. "What that really led to primarily was debt."

Options such as working longer and selling assets are not as risky as reverse mortgages or selling life insurance policies, two instruments marketed as ways to free up retirement cash.

A reverse mortgage allows homeowners to borrow from the home's equity in a lump sum, line of credit or regular payments, while not having to pay a monthly mortgage. The homeowner retains title and must pay insurance and property taxes while living there.

The loan and fees are due once all parties listed on the deed die, or the home is vacated for 12 straight months. The home is usually sold, and the proceeds from the sale are used to pay off the loan, plus interest and fees that can be up to 4 to 8 percent of the loan.

Reverse mortgages have become more attractive because the government raised lending limits to $417,000 last year, noted Eric Bachman, chief executive of Golden Gateway Financial in Oakland, Calif. But as equity drops, so does the amount one can borrow in a reverse mortgage, so timing is key.

However, experts such as AARP financial "ambassador" Jonathan Pond say reverse mortgages should be something of a last resort, because of high fees and the complicated nature of the loans. Reverse mortgages also mean the home will probably be sold at the end of the loan, mainly because the homeowner, or an heir, will want cash to pay off the mortgage. Seniors who want to leave their homestead to their children may not want to get a reverse mortgage.

Education is key, because of fears that reverse mortgage complexities could be used to trick seniors. To wit, the American Association of Residential Mortgage Regulators and the Conference of State Bank Supervisors established guidelines to be used starting early 2009 to review lenders and brokers selling reverse mortgages to seniors.

The guidelines are meant to guard consumers against fraud and abuse, "such as the simultaneous sale of unsuitable investments or deceptive sales practices," according to a December news release from the groups.

Finally, desperate seniors can sell their life insurance policy, either back to their insurer or on the private market. Bachman says insurers typically return 3 to 5 percent of the face value of the loan if it is bought back, but selling it on the private market could earn several times more.

This move, called a "life settlement," is risky because it leaves seniors without life insurance and financial security they had once desired to leave behind for loved ones.

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