Breaking the Home Equity Piggybank

For the vast majority of people “home sweet home” is their most valuable asset. Borrowing against a home can free up cash for many purposes that would otherwise be out of reach. Enter home equity loans and home equity lines of credit (HELOCs), both ways to access home equity without the homeowner having to sell. Home equity loans and HELOCs are essentially second mortgages that are secured by the home as collateral.

To calculate equity, subtract the amount you owe on your mortgage from your current property value. Generally, lenders will let you borrow up to 85% of your home equity, depending on your credit score and history, employment history, and monthly income and monthly debts. However, if you default on payments for either a home equity loan or a HELOC, the lender can foreclose on the property. That said, tapping into your home equity can be a sound strategy to raise cash for large purchases if and when you need it.

The rundown on home equity loans:

  • Lump sum
  • Fixed interest rate
  • Conventional loan structure separated into interest and principal
  • Monthly payments are predictable and don’t change.
  • Monthly payments are for a set period.
  • Monthly payments are made in addition to mortgage payments.

The rundown on home equity lines of credit:

  • Revolving credit line, money is withdrawn as needed (like a credit card).
  • Variable interest rate often begins at lower rate than home equity loans.
  • Conventional loan structure separated into interest and principal or interest-only payments
  • Monthly payments adjust up or down based on a benchmark interest rate.
  • Rising interest rates can increase payment.
  • You only pay interest on the money you withdraw, not the total credit available.
  • Some lenders allow partial or full conversion to fixed rate home equity loans.
  • The typical borrowing period is 10 years followed by a repayment period of 10 or 20 years.
  • During the borrowing period, you have to make minimum monthly payments on the amount you owe..
  • Once the borrowing period ends, you have to repay the remaining balance, like a conventional loan..
  • Interest may be tax-deductible.
  • You can make additional principal payments.
  • You can refinance.

Which option is right for you? Home equity loans could potentially be better for people who have an upcoming one-time expense with a known cost. For example, this might include home improvement projects, a down payment on another property, wedding expenses, emergency expenses, even credit card debt consolation. Home equity loans could also benefit people who want to avoid overspending. On the other hand, HELOCs could potentially be better for people who have upcoming variable or periodic expenses and would benefit from access to a revolving line of credit. For example, this might include home improvement projects, college expenses, medical bills, long-term care expenses, or a new business venture. As with most financial planning questions, the answer to this question depends on each homeowner’s unique circumstances, so this is a great question to discuss with a financial advisor.


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The Next Generation of Reverse Mortgages

When used appropriately, a reverse mortgage can be an effective tool for managing retirement income. If you are not planning to bequeath your home to beneficiaries, a reverse mortgage can provide an income stream to supplement your cash flow and protect your portfolio during market downturns. In the 80s and 90s, reverse mortgages were often used as a last resort and had a bad reputation due to high fees, overly complex arrangements, and scams. But fast forward to the current day where reverse mortgages are better regulated and insured, and rules are in place to prevent these kinds of abuses. For a senior whose wealth is tied up in an illiquid asset such as their home and who has insufficient income streams to provide a comfortable retirement, then a reverse mortgage could be a great choice.

What is a reverse mortgage? Basically, a reverse mortgage is the opposite of a conventional mortgage. Instead of turning the principal portion of your mortgage payment into home equity, you turn your home equity into money that you can use. A reverse mortgage allows you to borrow against your home equity and receive the proceeds in several ways: a lump sum payment, fixed monthly payments for as long as you live in the home (known as a tenure plan), fixed monthly payments for a term of your choosing (known as a term plan), or a line of credit. You can also combine one of the fixed monthly payment options with the line of credit. The loan balance is due when you die, move permanently, or sell the home.

How does it work? The lender makes a payment or payments to you, and you agree to pay the lender back with the equity you have in your home after you leave the home. Of course, you pay interest on the proceeds, but that interest is rolled into the loan balance. The upshot is as long as you are living in your home, you don’t have to pay anything back. You do continue to be responsible for property taxes, insurance, and home maintenance while receiving the proceeds. This is because you remain the owner, and keep the title to your home. Overall, the reverse mortgage increases your debt and decreases your equity.

An attractive feature of a reverse mortgage is that when it’s time to pay the loan back, you never owe more than the value of your home. If the amount you owe is greater than the value of your home, for example if home prices fall or you live longer than expected, your other assets are protected. In this scenario, the lender is reimbursed by the Federal Housing Administration (FHA) mortgage insurance program that you pay into over the life of the loan. If the amount you owe is less than the value of your home, you or your heirs keep the difference.

Here are the eligibility requirements:

  • 62 years of age or older
  • Own your home outright, or be able to pay off the remainder of your mortgage with the proceeds of the reverse mortgage
  • Occupy your home as a principal residence
  • Must be a single-family home, a two-to-four-unit home where you occupy one unit, a U.S. Department of Housing and Urban Development (HUD)-approved condominium, or a manufactured home that meets FHA requirements
  • Mandatory financial counseling to make sure you understand the risks and process of taking out a reverse mortgage

If you meet the aforementioned criteria and are weighing the pros and cons of various income streams for retirement, it may be worth adding a reverse mortgage to your assortment of options.

The Ongoing Property Tax Debate – California’s Proposition 5

Election season is fast approaching and eleven propositions are on the California ballot. The perennial challenge is to find the time to learn enough about each one to make informed choices, so I hope that providing a historical context for Proposition 5, currently on the ballot, is useful. Proposition 5 addresses the transfer of a home’s taxable value, in a long line of predecessor propositions addressing this same issue. Here is a brief survey of the related propositions, each of which amended the well-known and hotly-debated Proposition 13 to change who can transfer their home’s taxable value and how the transfers work.

Proposition 13 (1978): Decreased property taxes by using 1976 assessed property values, set tax rates at 1% of a property’s sale price, and capped annual increases at no more than 2%. Reassessment of a new base year value was prohibited except in the case of a change in ownership or the completion of new construction.

Proposition 58 (1986): Allowed the transfer of a primary residence between spouses or between parents and children without a reset on the home’s taxable value. In other words, the recipient of a house, whether a spouse or a child, would continue to pay the taxable value based on the limit set following the 1976 tax assessment.

Proposition 60 (1986): Allowed homeowners age 55 or older to transfer the taxable value of their present home to a replacement home, assuming the replacement home was of equal or lesser value, located within the same county, and purchased within two years of selling the original home.

Proposition 90 (1988): Allowed homeowners age 55 or older to transfer the taxable value of their present home to a replacement home in another county, but only if the county in which the replacement home is located agrees to participate in the program.

Proposition 193 (1996): Extended Proposition 58 by allowing grandparents to transfer their primary residence to their grandchildren without a reset on the home’s taxable value, when both parents of the grandchildren are deceased.

Proposition 5 (2018): Extends Propositions 60 and 90 by allowing homeowners age 55 or older, severely disabled, or who have contaminated or disaster-destroyed property, to transfer the taxable value of their present home to a replacement home, no matter the value of the replacement home, its location, or how many times the buyer has moved. The difference in market value between the present and replacement home would adjust the taxable value upward if the replacement home is worth more than the present home and downward if the replacement home is worth less than the present home. From Ballotpedia, the calculations are as follows:

Upward adjustment: (taxable value of present home) + [(replacement home’s market value) – (present home’s market value)]

Example: An individual sold her house for $500,000. The house had a taxable value of $75,000. She bought a replacement house for $800,000. The taxable value of the replacement house would be ($75,000) + [($800,000) – ($500,000)] = $375,000.

Downward adjustment: (taxable value of present home) × [(replacement home’s market value) ÷ (present home’s market value)]

Example: An individual sold his house for $500,000. The house had a taxable value of $75,000. He bought a replacement house for $300,000. The taxable value of the replacement house would be ($75,000) × [($300,000) ÷ ($500,000)] = $45,000.

It is once again up to the voter to decide if this is a ballot initiative that will continue to ease the homeowner’s tax burden and promote a culture of homeownership, or if it will continue to build up the tax disparity between older homeowners who pay lower tax rates and are disincentivized to move, and younger renters who want to buy but can’t afford the cost of entry at higher tax rates and suffer from a housing shortage. Affecting both sides, Californians are some of the most highly taxed people in the country, and the loss of revenue created by lower property taxes has resulted in higher taxes everywhere else.

 


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