Home equity could be an important source of financial security in retirement
Many aging Baby Boomers may be pondering their financial prospects for retirement with some trepidation. But they also may be overlooking home equity they could use to improve financial security in their golden years, according to the authors of a new Fannie Mae-sponsored report from the Urban Institute.
Barbara Butrica and Stipica Mudrazija — the authors of the working paper — suggest that home equity could offer some help for Boomers who are not adequately prepared for retirement.
Short on Savings
They cite a 2012 study from the Urban Institute that finds between 30 and 40 percent of Boomers at age 70 won’t have enough income to adequately replace their pre-retirement earnings.
In that study, researchers defined adequate income at age 70 as at least 75 percent of average annual pre-retirement earnings from ages 50 to 54. They did not, however, include the annuitized value of home equity in projecting retirement income.
The amount of home equity is hard to overlook. It’s “enormous,” Burtica and Mudrazija say. The Federal Reserve Board’s 2013 Survey of Consumer Finances estimates that Boomer home equity totals $6.3 trillion. And they say this equity has at least a potential role in addressing retirement needs — acknowledging that there are complications along the way.
“For most adults near traditional retirement age, a home is their most valuable asset — dwarfing retirement accounts, other financial assets, and other nonfinancial assets,” write the authors. “Although relatively few retirees tap into their home equity, having it provides financial security.”
“In fact, many retirement security experts argue that the conventional three-legged stool of retirement resources — Social Security, pensions, and savings — is incomplete because it ignores the home,” they write.
The new paper on “Home Equity Patterns among Older American Households” is the first in a series Fannie Mae is sponsoring. The economists are using data from the Health and Retirement Study (HRS) — a national representative survey of older adults — to explore the topic.
Homeownership and Home Equity Holding Up
The study offers the welcome news that homeownership rates have held up well for Baby Boomers despite the housing bust that marked the Great Recession and a subsequent decline in the overall rate.
Consistent with data from the Census Bureau, HRS data show that the share of households age 65 and older who own their home increased slightly from 75.3 percent in 1998 to 78.2 percent in 2012 — with a small decline in 2014.
And while the housing market’s latest boom-and-bust cycle has been abnormally tumultuous, home equity has held up for older households.
The typical owner-occupied household age 65 and older saw its home equity increase 42 percent between 2000 and 2006 — from $117,000 to $166,000, in inflation-adjusted 2015 dollars. Equity then declined 22 percent through 2012 — to only $129,000. But, as the report points out, this was still 10 percent higher than the level in 1998 — the year in which the run-up in housing prices began. Also, home prices have increased since 2012.
Increasingly Indebted, Leveraged
On the more sobering side, the paper also finds an increase in housing debt among these homeowners. The share of 65-and-up owner-occupied households with housing debt increased from 23.9 percent in 1998 to 35 percent in 2012. And the level of housing indebtedness nearly doubled during that period — from a median of $44,000 to $82,000.
Most of this rise in housing debt occurred before the recession. Following the onset of the recession, debt did continue to grow — more slowly — “as people lost their jobs, incomes fell, and families struggled to make ends meet.”
The authors surmise that borrowing against equity to meet rising medical costs might have played a role in rising debt. But they suggest that more important factors were changing societal attitudes about debt and the false security in home equity that the rapid rise in home values created in the early 2000s.
The report also voices concern that “older adults have become increasingly indebted, and more importantly, increasingly leveraged” (with a higher percentage of debt against the value of their home) — especially among low-income and non-Hispanic black households.
Between 1998 and 2012, the median amount of housing debt among older homeowners carrying such debt increased 86 percent overall but 113 percent for low-income households and 150 percent for black households.
The median loan-to-value ratio increased 42 percent overall for older homeowners, but 100 percent for low-income households and 68 percent for non-Hispanic blacks.
“If these trends continue into the future, retirement security will increasingly depend on retirees having enough income and assets to pay for basic living expenses and to service their debt,” Butrica and Mudrazija observe.
They cite a previous finding that older adults are dealing with their indebtedness by delaying their retirement and Social Security benefits. Ideally, they say, older adults would pay off their debts before reaching retirement age.
Illustrating the Value of Equity
Nevertheless, their analysis shows, most older homeowners — and even those with housing debt — have amassed substantial equity in their homes.
For illustrative purposes only, the researchers estimated the potential role that home equity could play in bolstering retirement security. To illustrate the value of equity, they looked at the amount of annual income households might have if they sold their homes, placed the proceeds into an annuity, and became renters.
“At the pre-recession peak, owner-occupied households could have increased their incomes 54 percent — from $39,000 to $60,000 — by selling their homes and annuitizing the proceeds,” they write. “Even in 2012, selling their homes and annuitizing the proceeds would have increased their incomes 40 percent — from $35,000 to $49,000.”
The authors add that home equity levels vary widely among older adults. And they document these disparities, showing, for example, that older whites have homeownership rates that are nearly 20 percentage points higher than elderly blacks and Hispanics, and older white homeowners have nearly twice as much home equity as their black and Hispanic counterparts.
Both black and Hispanic homeowners age 65 and older could increase their incomes by about 40 percent by amortizing their home equity — a slightly higher amount than white homeowners could gain by doing the same. But their median incomes would continue to be “dramatically lower” than those of their white counterparts.