Most clients have a decent chunk of their net worth tied up in their home(s). But whether it’s for wants or for needs, the clients may not know how to generate income or cash from these properties, without selling the place(s) sooner than they would prefer.
Here are some ways homeowners can use value accumulated in residential real estate to help cover regular or extraordinary expenses.
Home Equity Line of Credit
The time to establish a home equity line of credit (HELOC) is before it’s needed (especially if the client is soon retiring). The HELOC allows the clients to borrow against the equity they have in the home, up to a preestablished limit. The cost to establish a HELOC can range from nothing, up to a couple thousand dollars, and may require an appraisal and review of the client’s credit report (but not always).
The interest rate can fluctuate and is usually tied to a specific index. However, there is generally a cap in place on both the degree that the rate can rise over a certain period (often a year) and an overall limit on the maximum interest rate. The borrowers owe interest only if they actually tap the HELOC, and then only on the amount they borrow. Initially, the monthly minimum payments are just the interest on the borrowed amount, but eventually the lender may request that the borrowers convert the HELOC to a home equity loan.
Home Equity Loan
This minimortgage is best for clients who have a specific project/expenditure in mind, such as a larger home remodeling project, but who aren’t willing or able to pay for the project from liquid savings.
Like the HELOC, the home equity loan may require an appraisal and credit check, and the origination fees are similar. Unlike the HELOC, approved borrowers using a home equity loan will get their requested amount right away—and be obligated to make monthly payments of both principal and interest over the life of the loan (usually five to 20 years). As such, clients may want to take out the longest home equity loan they can stand, since even if there is a higher interest rate associated with that term, the monthly payment is likely to be lower (and more affordable).
Rent It Out
If the clients have at least one unneeded and unoccupied property, they can rent it out for a year at a time to qualified tenants.
Note that the screening, showing, management and maintenance of a rental property might be more work than most retired clients are willing and able to perform. That said, a property management company can take care of most or all of the owner’s responsibilities, for a fee that tends to run between 10% and 15% of the total monthly rent.
Clients who live in nonrural areas may want to check with local health care organizations, large employers and universities, all of whom often have permanent or temporary employees or students who are looking for a home to live in and either can’t afford or don’t want to buy one.
Those clients who have a place on or near the water or in a prime recreational region have an opportunity to generate a significant amount of income, albeit with a lot more work involved.
Sites like Airbnb and Vrbo can give clients an idea of the going rate for daily, weekly or monthly rentals of similar properties in the relative area and also provide a platform of tools necessary to manage the reservations and payment processes. And even if the client’s property isn’t in a prime vacation area, there is still a chance for money to be made renting it out for the holidays, sporting events, or other big gatherings and festivals.
But a couple of words of warning: First, short-term stays mean more money per night but also a lot more work, as every time a customer checks out, the place needs to be cleaned, and the laundry has to be done before the next customer checks in. And, as with any type of home rental, the clients should check the local zoning laws to ensure the activity is permitted, and to determine if they need to adjust their homeowners’ or personal liability insurance coverage.
Clients who are over age 62 can consider getting a reverse mortgage for a portion of the equity established in their home.
A reverse mortgage doesn’t have the stringent application standards required by a normal mortgage. And there are no monthly repayments required (although the homeowner can choose to pay off the borrowed amount). Instead, interest is added to the borrowed amount.
Once the borrower dies or leaves the home for at least 12 months, the home is sold and the proceeds are used to pay off the balance of the reverse mortgage.
If the amount of the sales proceeds exceeds the balance of the reverse mortgage, the owners (or their heirs) receive the remaining amount. But if the sales proceeds don’t exceed the reverse mortgage balance, the owners and heirs get nothing but owe nothing.
Clients can ultimately always sell their house and use the proceeds to cover financial obligations or goals.
First, they may choose to move out of a stand-alone home and use the proceeds to buy a less-labor-intensive condo (without having to go through getting approval for a mortgage). Or they could pay for several years/decades of the rental cost of an apartment. Assuming there isn’t another partner who needs to remain in the home, it can also be sold to pay for assisted living and nursing home expenses.
Finally, the home sale proceeds can be used to provide a bequest to family heirs or charity. And knowing that those parties will be provided for after the clients’ death may encourage clients to get more enjoyment from spending their liquid savings during life.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).