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Should I Stay Or Should I Go?

Sell The House To Help Fund Retirement?

August 10, 2012 • DebtTaxationRetirement PlanningMortgagesLoansFinancial PlanningSavingsRentingTax Planning

Real estate values have been climbing for years.  For many retirees and near-retirees there's a serious question being asked at the dinner table: should we sell the house and use the cash to help fund/enhance our retirement?

Before we look at the selling option, let's first look at how you might stay in the house and use it to generate cash by:

1) renting out part of the house, and/or

2) taking out a reverse mortgage.

 

 

 

 

Generate cash by renting out or taking a reverse mortgage
   
   RENT OUT PART OF THE HOUSE                             
Pros 1. You don't have to sell the house 
  2. The cashflow can be significant 
  3. You continue to benefit from the tax free growth of the house's value 
  4. A proportionate share, based on square footage rented, of your house expenses (realty tax, repairs, mortgage interest, etc.) can be used to offset the rental income for tax purposes 
Cons 1. The cost of renovations to create a separate unit
  2. You have to become a landlord  
  3. If separate units are not legal in your neighbourhood your neighbours may complain and you then have to incur the cost of making it legal, if possible  
  4. The cashflow is not guaranteed and may be interrupted by periods of vacancy 
                                           OR
  TAKE OUT A REVERSE MORTGAGE
What is it? A reverse mortgage allows you to tap into the equity in your house. An ordinary mortgage decreases over time as principal and interest payments are made.  A reverse mortgage is the opposite: it increases because no payments have to be made, the accrued interest is simply added to the outstanding balance.  There are two ways to take out a reverse mortgage: formally and informally.
Formal Reverse Mortgage With a formal reverse mortgage, the lender gives you a sum of money based on the value of your house and your age.  Both you and your spouse have to be at least 55 to qualify.  The mortgage can be for no more than 50% of the value of your house.  For example, if my wife and I were 55 today, based on a house in Toronto, we would receive 20% of its value as a formal reverse mortgage.  The reverse mortgage does not have to be paid back until you move out or you and your spouse die.  With a formal reverse mortgage the amount owing is guaranteed never to exceed the value of your house, which provides a measure of security.  For more details visit the CHIP Home Income Plan at http://www.chip.ca/index.cfm?id=100&language=english  
Informal Reverse Mortgage A less expensive and more flexible option is to take out a Line of Credit where you do not have to make any payments, i.e., where the interest is simply allowed to accumulate.  You can't do this with a traditional line of credit, but you can with a Manulife ONE account. The interest rate will be lower than with a formal reverse mortgage, you can get as much as 80% of the value of your house, and you can draw the money out monthly rather than taking a lump sum which will minimize the accumulation of interest.  But you have to watch that the growing mortgage balance does not exceed your limit. For more details visit the Manulife ONE homepage at  http://www.manulifeone.ca/about-manulife-one/
Pros 1. You don't have to sell the house
  2. The income from the reverse mortgage is tax free
  3. Today's low interest rates mean the mortgage grows slowly
  4. You continue to benefit from the tax free growth of the house's value  
  5. With a formal reverse mortgage you never have to worry that the mortgage amount will outstrip your equity
  6. With an informal reverse mortgage you have the freedom to draw money on a montly basis to minimize interest costs 
  7. If you use the reverse mortgage dollars to buy investments, the interest on the reverse mortgage will be tax deductible.  This is a great benefit, but please talk to your accountant or tax professional to make sure you set it up correctly.
Cons  1. The emotional aspect of having increasing debt in retirement may bother you
  2. When interest rates rise the mortgage will grow quicker 
  3. With a formal reverse mortgage the costs are higher  
  4. With an informal reverse mortgage you have to watch that the mortgage balance does not go any higher than your limit 
  5. You are 'eating' your home equity, so there will be less for your heirs 

 

The stay or go decision is about more than the financial issues.  You may love your house because that's where you raised your family, it's where your cherished memories are, and you want to hold onto them. You may feel an emotional connection to your house.  Or it may be in an ideal location for the lifestlye you lead, it may possess the creature comforts that have become important to you, or have other features you want to hold onto in your golden years, like a beautiful garden, arts and crafts room or kitchen, etc. 

If you want to stay and it's expensive and you don't want to rent out or take out a reverse mortgage then you are going to have to cut back in other areas.  Do you know where you are spending your money?  If you don't, I suggest you start tracking lickety-split so you'll know where to cut.

Sometimes, I see couples 'argue' about the stay or go decision.  One spouse is tired of looking after the house, while the other enjoys the amenties and environment which the house offers, and which they have grown accustomed to. 

If you do decide to sell, let's look at the options and their pros and cons in the table below.

  

Options if you decide to sell your house
   
  A. BUY A CONDO
Pros 1. You pocket the difference
  2. If it's brand new or newly renovated, the appliances, fixtures, flooring etc will be new
  3. You no longer have to maintain the outside of your house; this is a hassle-factor benefit and a dollar savings benefit
  4. In most cases, your utility costs will go down; your property taxes may also be lower
  5. The amenities may allow you to drop the cost of a gym membership, or motivate you to be more physically active
  6. The condo may offer more personal security and far easier physical mobility - no more stairs!
  7. If you are now closer to mass transit, you can give up one or both cars
  8. If you intend to take out a mortgage to pay for part of the condo then you should buy the condo with no mortgage, but then borrow the amount that would have been the condo mortgage (use the condo as security to get the lowest rate), and use that money to invest to generate retirement income; your interest costs will then be tax deductible! This is a great benefit, but please talk to your accountant or tax professional to make sure you set it up correctly.
Cons 1. Condos are expensive, so you may have to downsize your space considerably to have money leftover to help fund your retirement 
  2. Watch those monthly condo fees, they can be high, as well as special assessments which are a factor in older buildings 
  3. Will you have to put up with a Board of Directors with grumpy, ill-experienced members 
  4. No more garden and sitting out on the verandah
  5. Watch for the type of community in the condo: you might not be happy if there are a large number of renters who generally do not have the same long-term goals as owners
  6. Living in a building is not for everyone
  OR
  B. BUY A SMALLER HOUSE
Pros 1. You pocket the difference
  2. If it's brand new or newly renovated, the appliances, fixtures, flooring etc will be new 
  3. Your utility costs and property taxes will be lower
  4. Less house to take care of 
  5. If you are now closer to mass transit, you can give up one or both cars
  6. You could buy a duplex or a property with an apartment that will generate income
  7. If you intend to take out a mortgage to pay for part of the house then you should buy the house with no mortgage, but then borrow the amount that would have been the house mortgage (use the house as security to get the lowest rate), and use that money to invest to generate retirement income; your interest costs will then be tax deductible! This is a great benefit, but please talk to your accountant or tax professional to make sure you set it up correctly.
Cons 1. Will you pocket enough to have made the move worthwhile?
  2. Smaller houses may be in more expensive neighbourhoods or may need extensive renovations which may wipe out any savings 
  OR
  C. MOVE TO AN APARTMENT
Pros 1. You'll now have all the equity from your house to put into your retirement portfolio.   
  2. There will be lots of units to choose from as many investors have bought condos to rent out 
  3. If it's a brand new or newly renovated condo that's being rented out, the appliances, fixtures, flooring etc will be new
  4. You no longer have to maintain the outside of your house; this is a hassle-factor benefit and a dollar savings benefit
  5. Your utility costs will go down or be incorporated into the rent
  6. The apartment may offer more personal security and far easier physical mobility - no more stairs!
  7. If you are now closer to mass transit, you can give up one or both cars
Cons 1. You may have to give up a lot of space   
  2. You may not be happy with apartment living, although if it's a condo you are renting it may not feel apartmenty 
  3. You can't make changes to suit your lifestyle the way you can in a unit you own 
  4. No more garden and sitting out on the verandah

 

In the end, the decision will come down to both rational and emotional issues.  

On the rational side, what are the numbers?  How much will you get for your house?  After you pay all your debts, how much will be left over to put into your retirement portfolio?  Assuming a 25-year lifespan, each $100,000 will generate, at an assumed rate of 4%, a monthly before-tax income of $525 for 25 years.  So if you unlock $500,000 of equity in your house, that's going to give you an additional $2,625 ($525 x 5) per month, before-tax, which is significant.

Ok, so that's the rational side.  On the emotional side you have to think about your attachment to your current house, and the area you live in, and how you are going to feel in a condo, apartment or smaller house, and potentially in a different neighbourhood.

Sit down and work through the numbers. 

If you want help with the analysis, just get in touch with me at izhak@financialfanatic.com and we can schedule a meeting, either in person, or if you are not in Toronto, over the telephone.

Please do not hesitate to comment below on any pros or cons, or indeed other options, you think are missing from the list.  If you've already made the move, please share with us: how did it go?

Be well,

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