One of retirement’s great promises is the thrill of kissing that monthly mortgage payment goodbye. But don’t start puckering up just yet.
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Let’s take a few moments to talk about the different choices you have when it comes to the withdrawal of the equity in your house.
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Bill and Elaine Nolan paid top dollar when they bought their Tiburon, Ca., house a few years ago at the height of real estate frenzy.
Now, of course, the California housing market is cooling rapidly.
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Tapping cash from your residence can go beyond the standard home equity loan and line of credit. Consider these ways to accomplish the goal:
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How can you take out equity without taking out a home equity loan or following through on a cash-out refinancing?
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It may be a slow housing market, but approximately 82 percent of Freddie Mac-owned loans refinanced during the quarter resulted in new loans that were at least five percent larger than the original amount of the previous mortgage.
This is the same percentage of cash-out refinances as was reported in the fourth quarter of 2006.
Don’t count on home equity to come through with a significant portion of retirement funding, advises a new report by Fidelity Investments.
According to the study, home values underperformed stocks and bonds over every five- and 10-year period from 1963 to 2005. Home values have been slightly above the returns on treasury bills during the same time, according to the report, “The Equity You Live In: The Home as a Retirement Savings and Income Option.”
“When we started the work, the real question was: If I have home equity, how should I think about using it in retirement,” said Guy L. Patton, executive director of the Fidelity Research Institute. “The conclusion: The returns on residential real estate are probably less than what most people think they are.”
Over the more than 40-year period, real compound returns on stocks outpaced that of residential real estate, with 5.95% average annual returns on stocks compared with 1.35% in realty. A dollar invested in stocks in 1963 would have compounded to $12.36 by 2006, while the same dollar would have grown to $1.79 in real estate.
Is residential real estate a profitable investment?
The median home price of new residences in the United States has risen since the early 1970s, with an average annual appreciation rate of 5.9% since 1963. However, there have also been sharp corrections three times during the time period.
It’s one thing if the homeowner is able to “ride out” the sharp downturns; it’s another if they’re considering the home as a potential retirement asset in the near future, the report noted.
That said, for many Americans in or approaching retirement, home equity is the largest nonpension asset they can draw on for lifelong income, the report said. And there are plenty of Americans who plan to - and perhaps need to - tap their home equity in retirement, hence the use of cash-out refinancing.
About one in five of those between the ages of 55 and 75 have used or plan to use equity in their home to help fund retirement. The survey also found that two-fifths of retirees moved after they retired and 15% plan to move. Twenty-three percent of preretirees plan to move; another 29% are unsure if they will.
Thirty-five percent of preretirees believe their reason for moving/applying for new home loans will be to access home equity, while only 10% of retirees are motivated by equity. Thirty-one percent of retirees received more than they thought they would when they sold their home and relocated, while 23% earned less than they expected.
Eight percent of retirees who leveraged their home equity used a reverse mortgage to do so, the survey found.
SOURCE: MarketWatch
Need extra equity from your home? Consider cash-out refinancing. More owners these days are doing just that than ever before.
Why is this the case? It’s all about dollars and cents, according to Amy Crews Cutts, deputy chief economist with Freddie Mac.
Because home equity loans and lines of credit are most often tied to the prime rate (now at 8.25%) those options have grown more expensive, even as long-term mortgage rates have remained relatively low, with the 30-year loan averaging about 6.2%.
“It’s all about the prime rate,” said Michael Kodsi, chief executive officer of Choice Mortgage Bank in Boca Raton, Florida.
A good number of his clients would rather take cash out through mortgage refinancing — where their mortgage rate will be fixed — as opposed to taking out a loan tied to the prime rate, which has the potential to fluctuate and thereby “could go higher down the road,” he said.
Freddie Mac said 89% of the loans it owns that were refinanced in the third quarter of 2006 had loan amounts at least 5% higher than the original mortgage balances, the threshold for considering a loan a cash-out refinancing.
It’s the highest share of cash-out refinance loans reported since 1990.
Consumers cashed out a total of $82.8 billion during the quarter, down somewhat from $90.6 billion in the second quarter. And banks are seeing results of the cash-out trend, too.
“Banks have been reporting that they have not been getting the business of home equity lines as they had been before,” Cutts said.
According to the American Bankers Association, the dollar amount of home equity loans (including loans made through home equity lines of credit) has increased by an annualized 14.6% for the first three quarters of 2006, compared with all of 2005. That’s down from a 17.4% increase in 2005 and a 31.2% increase in 2004.
The “easy money” in 2004 was an effect of a prime rate at about 4%, said Keith Leggett, senior economist for the American Bankers Association. But as the Fed raised rates, thereby raising the prime rate, that easy money dried up.
“What’s happening, you’re starting to see the impact of higher interest rates,” he said. “As interest rates rose, that … translated into basically a slowing in the rate of growth in home equity lines and home equity loans.”
Mortgage refinancing anyway
Some owners aren’t refinancing only to get at their home equity. Instead, they’re “passive” cash-outs taken by those who are refinancing for a better rate, perhaps in response to an adjustable-rate mortgage reset that has adjusted higher, Cutts said.
In fact, it’s those who are facing adjustable-rate mortgage resets that seem to be the driving force behind an upswing in refinancing that started late last year, said Mike Fratantoni, senior economist at the Mortgage Bankers Association.
While locking in a good rate, some of these homeowners are using the opportunity to pull equity out of their homes while they have a chance - a move that perhaps helps them clean up credit card debt at the same time, said Keith Gumbinger, vice president of HSH Associates, a financial publisher of mortgage and consumer loan information.
That said, a growing number of homeowners recently have been increasing their mortgage rates through refinancing.
“The median borrower increased their mortgage rate by 12%,” she said, referring to statistics from the third quarter of 2006.
The borrowers considered for that statistic originally had fixed-rate home loans, but refinanced either to an ARM or another fixed-rate.
The housing slump is slightly eroding a key driver of consumer spending, but stock market gains are boosting the average household’s net worth, new Federal Reserve data show.
Homeowners possessed $10.9 trillion in equity stored up in their properties at the end of the third quarter, an amount that was essentially flat compared with the previous quarter and down from a nearly 3% rate of growth during the same period last year, the Fed said and The Wall Street Journal Online reported.
Home equity - the difference between a home’s value and the amount owed on its mortgage - fell to 53.6% of the value of household real estate, down from 54% in the second quarter and 54.6% a year ago.
Steady home price appreciation in recent years swelled the amount of equity built up in houses, while consumers tapped it to finance home improvement loans, college educations and other purchases. But the data from the Fed’s “flow of funds” report suggest the housing market’s slump has whittled away the growth of home equity.
So far, the impact on consumer spending has been modest. But many economists worry that further weakness in the housing market, particularly if it leads to an outright drop in house prices, could shrink home equity and lead consumers to pull back in the months ahead.
There are bright spots, though.
The competitive labor market is boosting wages, and the stock market has produced big gains for many investors so far this year. After declining slightly in the second quarter, the value of household financial assets rose nearly 2% in the third quarter to $40.5 trillion, the Fed said.
That combination helped lift household net worth, which was flat in the second quarter, by 1.5% in the third quarter to $54.06 trillion.
It looks like households are still in pretty good shape,” said Robert Mellman, senior economist at J.P. Morgan Chase & Co. “The fundamentals for consumer spending are really quite good.”
That may be true, but they also appear to be turning cautious. In a separate report yesterday, the Fed said consumer borrowing - on resources such as a debt consolidation mortgage - decreased by 0.6% in October, the largest monthly drop in 14 years.
“In the grand scheme of things, households are stepping back a bit and being more conservative,” said Daniel Jester, an economist at Moody’s Economy.com.