The already-weak argument that owning a house is a retirement plan looks even worse today thanks to rising interest rates.
Just like renters, homeowners need personal retirement savings in a pension, a tax-free savings account or a registered retirement savings plan that can be used to cover living costs from year to year. Houses can play an important role in your retirement plan, but they’re not enough on their own.
Rising interest rates demand we take a fresh look at the role of houses in retirement. Higher rates make it harder for homeowners to find money to put away for retirement, and they add to the cost of putting the equity in a home to work to generate retirement income. Keep this in mind if your rationale for buying into an expensive housing market includes a secure retirement.
There is a way your house can help pay for your retirement, but it won’t work for the majority. Just sell the family home as you exit the work force and move somewhere much cheaper. The profit from this sale, tax-free if it’s a principal residence, could be invested in a way that produces a lifetime stream of income.
Somewhere cheaper could mean a smaller community, but you may not want to move away from friends and family. A smaller home is also a possibility, but you may find the condo or townhome that suits you in retirement uses up most of the proceeds from selling your family home.
The more likely housing outcome in retirement is that you want to stay in your home indefinitely. The virtues of remaining at home versus institutional care have been highlighted like never before in the pandemic.
Staying in your home exempts you from paying potentially expensive monthly rent in retirement, but you still have home upkeep and property taxes to cover. Owning a home also gives you an asset you can sell if you ultimately require long-term care.
The well-prepared retiree has a portfolio of retirement income sources – Canada Pension Plan retirement benefits, Old Age Security, personal savings and, for roughly 37 per cent of workers, a company pension.
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 per cent of a home’s value (up to 80 per cent 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.
Another way to pull equity out of your home is a reverse mortgage. You can borrow up to 55 per cent of your home’s value with a reverse mortgage and not pay interest or principal until you sell.
The rise of interest rates off the historic lows of the pandemic affects both of these tools for freeing up home equity. There’s no way of knowing where rates will be when you retire and want to use a HELOC or reverse mortgage, but it’s a near certainty that they will be higher than recent levels.
HELOC rates are typically set at the prime rate by your lender, plus a markup of something like 0.5 per cent. Today’s prime rate of 3.2 per cent could easily be more than 4 per cent by year’s end, if current rate forecasts are correct.
Reverse mortgages cost a fair bit more than traditional mortgages – HomeEquity Bank had a variable-rate product at 5.74 per cent early this week, a fixed one-year rate of 6.34 per cent and a five-year rate at 7.34 per cent. A traditional five-year fixed mortgage can be had for about 4 per cent right now.
For households with lots of home equity and a need for short-term cash, reverse mortgages can make a lot of sense. But carrying one of these mortgages for an extended period would be expensive.
The ideal approach for homeowners is to diversify their retirement savings portfolio with TFSAs and RRSPs. Also, with maximum contributions to workplace pensions if they’re available.
Retirement saving may not be feasible in the early years after buying a home and starting a family. No worries – it’s fine to postpone retirement saving for a while.
Actuary Fred Vettese has written an entire book on how homeowners can put money away for retirement called The Rule Of 30: A Better Way to Save for Retirement. The key here is “save for retirement.” Even if you own a house, you need to do this.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, May 2, 2022