How Retirement became much more expensive

Why retirees may be forced to tap into their home equity

Thanks to runaway inflation and rising interest rates retirement just got a whole lot more expensive. This also makes extracting home equity more costly. Personal finance columnist Rob Carrick writes in the Globe & Mail, “There are a couple of ways to squeeze additional retirement income out of your house. One is a home equity line of credit, which lets you borrow up to 65 percent of a home’s value (up to 80 percent for a combination of HELOC and mortgage). You must pay interest owing on  your HELOC every month, but you could postpone repayment of principal until you sell the property.” 

As we mentioned on this show last week HELOCs are likely to disappear as home values fall. After all, why would banks want to take the risk of lending money secured by a depreciating asset? It’s the cold calculus of banking. And contrary to Carrick’s statement, most HELOCs here in the States require principal and interest payments after the draw period has ended.

Many retirees are going to have to…

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1 comment

James E. Veale, MBT May 9, 2022 at 8:17 am

Many people confuse the profit (or loss) from selling their principal residence with the net cash proceeds from the sale. In most cases they are very different numbers.

For example, a widower (for 4 years) asked his very smart neighbor what kind of gain he would have on his home if he sold it in the next four months. His neighbor, a moderately successful and prudent entrepreneur estimated the gain at about $340,000.

The widower had told his neighbor that he and his wife had purchased the home in 1960 for $35,000 and had invested $75,000 from savings in 1985 in “improvements.” The widower said that his Realtor had told him that the house was now worth $490,000 but selling and fix up costs would total about $40,000. So based on what the Realtor and neighbor told him, the widower planned on having about $340,000 in cash from the sale.

Two months later, the house sold for $500,000 with selling and fix up costs of $41,000. The current UPB (unpaid principal balance) at the time of sale on the fixed rate HECM originated in 2009 was $289,000. Even though the profit on the house was $349,000 for income tax purposes, the net cash to the seller was just $170,000. The widower was fully upset and called his income tax planner for some practical advice. Since the income tax gain on the house was over $250,000, his tax planner tells him to expect to pay an additional $30,0000 in federal and state income taxes leaving just $140,000 in net cash for the widower to use in buying his next home. The widower asks about a huge interest deduction he should be getting from the payoff of the HECM along with a $500,000 exclusion on the gain of the sale of his house, only to hear 1) none of the interest will be deductible since the funds were used to pay for his wife’s final costs as well as for both of them to live on for 9 years and for himself alone for the last four years and 2) that the $500,000 exclusion on the gain of the sale of principal residence only applied to married couples and surviving spouses in the first two years following the death of the decedent spouse. The widower was planning on using his “profit” from selling the home to right size using an H4P plus having substantial cash left over. He now realized his idea of downsizing needed revision with no cash left over to live on.

Profit and cash flow from the sale of a home are not the same and each must be carefully estimated. In the go-go days of residential homes in the 1970s here in Southern California, many tax clients came to me asking what the approximate profit would be from selling their home. I quickly learned that what they meant to ask was how much cash will be available to them by selling the home. With spectacularly rising prices and gain deferrals (rather than today’s exclusions) for income tax purposes on gains from the sale of a principal residence, they were trying to determine if they had enough money from the sale of their home to make the down payment needed for their next dream home.

Using imprecise terms can result in unexpected results for HECM borrowers. So can anyone explain why we still hear originators calling HECM proceeds income?

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