Equity Harvesting!
A critically important issue these days is whether or not we are saving enough for retirement. With longer life spans and increasing uncertainty about Social Security, it’s becoming ever more important to sock away as much as possible into retirement accounts. But unless you have a lot of expendable income, finding that extra money to invest may be tough. The question then becomes where to look for investment money. Does retirement planning have to be short-changed in favor of meeting current financial obligations? Not necessarily.
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Another Way To Tap Your Home If you’re nearing retirement and find yourself looking at too small a nest egg, here’s another way to use your home equity to help finance
your golden years. Consider selling your house and moving to a smaller one, especially if you have significant equity in the home. If you’ve lived there for at least two of the last five years, you can exclude $250,000 of gain if you are a single taxpayer and $500,000 of gain if you are married filing jointly. Assuming you had some equity, you can sock away the proceeds into a sound investment strategy for the future. At a minimum, you should be able to reduce your living expenses, leaving you with some extra money to invest. |
Instead of trying to find “new” money, why not evaluate existing assets to see if they can be culled for cash? This technique, called “equity harvesting,” has been around for years; but it is only recently receiving attention from investors as a viable retirement planning strategy. One option for harvesting equity is to refinance the mortgage on your personal residence. However… this is a path that should only be pursued after careful consideration.
Proceed with Caution
Just a few years ago, during period of remarkably high house values, many homeowners stripped the equity in their homes, invested it in the stock market, and then lost it when stocks tumbled. Add to that the fact that housing values also declined, leaving homeowners in serious financial straits. For many, instead of retiring as planned, they will find themselves working longer than they expected. Leveraging assets is great when it works, and can be disastrous when it doesn’t.
If you and your accountant decide that refinancing is a workable solution for you, here’s how this works:
The idea is to minimize monthly mortgage payments so that the money you save can be invested for retirement. Keep in mind that when you refinance, your lender can charge a number of fees including application, appraisal, origination and insurance fees. Plus you may have to pay for title search and legal costs. There is the possibility that these costs can be reduced if you refinance with your current lender.
Another important issue to consider before choosing this plan is that it will take some time to break even. That is, it could take several years before the saving generated by refinancing exceeds the costs associated with refinancing. The longer you plan to stay in your home, the better your chances of recouping those costs and seeing additional income that can be invested for the future. On the other hand, if you intend to remain in your home for only a few years, you probably won’t reach the break-even point.
Finding Break-Even
Before you can know if harvesting the equity in your home will pay off, you need to calculate how long it will take to cover the refinance costs. You can determine that by dividing the cost of obtaining the new loan by your monthly payment savings. The result will tell you how many months it will take before you start saving money. If you plan on staying in your home past this time, then refinancing to harvest equity is an option you should consider.
In general, the best time to refinance is when the break-even point is less than 36 months. If it takes longer than three years, give the decision some serious thought. And if takes longer than five years, chances are it will not be prudent to refinance.
Moving your equity from one asset, like your home, into a more productive asset can be a smart use of your money… but bear in mind, this path is not for everyone. It’s critical that you sit down with your accountant and run the numbers before taking action.
