Inflation and Retirement: What are Your Options?
By: Courtney Jorstad
April 5, 2023 • 6 minute read
With the largest increase in inflation within a 12-month span since 1981, consumers are feeling more financial strain than ever. Retirement can be especially challenging during times of increased inflation, leaving those living on a fixed income especially vulnerable.
Energy prices such as motor fuel, electricity, and natural gas have faced some of the biggest hits when it comes to cost increases, according to the U.S. Bureau of Labor Statistics. And these increases are making essentials significantly harder for those on fixed incomes to afford.
“Higher expenses introduce additional risk to a retirement plan.” Brian Walsh from SoFi noted in an interview with Forbes. “First, expenses may rise at a faster rate than their fixed income. This creates the need to either reduce spending or withdraw more money from investments during a bear market.”
The pandemic played major role in the cost-of-living increases: the Consumer Price Index (CPI) rose 2.3 percent in 2019 compared to an increase of 7.0 percent for 2021 alone, according to the Council of Economic Advisers’ 2022 Economic Report of the President.
What Options Do Retirees Have?
As retirement approaches, many seniors are looking for solutions that allow them to maintain a steady cash flow while also keeping monthly costs low.
Those who own a home that is paid off or have substantial equity built up may be able to tap into that equity to supplement their income in a variety of ways.
Sell Your Home
In many areas, home prices have also increased along with goods and services, which may make it appealing to sell.
Selling your home will give you access to equity while also giving you freedom to decide if renting, living with family members, or downsizing is right for you.
However, one thing to keep in mind is that if you want to use the proceeds to purchase a new home, home prices are up everywhere. You will want to be sure that this direction is worth it to meet your goals.
Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (HELOC) is a type of second mortgage that provides homeowners with a line of credit which is similar to a credit card. They can withdraw money from the account, pay it back, and then borrow more from the same source.
HELOCs come with a variable interest rate and the credit limit is based on the equity you have available. Generally, individuals can borrow a maximum of 85% of their home’s worth after subtracting the mortgage balance.
A home equity line of credit may be a good choice for those who want the flexibility of a line of credit to withdraw funds on an as needed basis. HELOCs may be a good option for those who are looking to increase their emergency funds.
Nevertheless, it’s essential that the borrower has the capacity to reimburse it once the draw period has expired.
Home Equity Loan
A home equity loan is similar to a home equity line of credit (HELOC), in that both types of financing are seen as second mortgages. The first distinction is that a home equity loan is dispensed in one large sum, whereas a HELOC is available to use as a line of credit.
Repayment of the home equity loan is done through fixed monthly payments over a set period, which typically ranges from five to thirty years. These payments must include both the principal and interest.
It is possible to take out a home equity loan on either a primary or secondary residence. This type of loan is secured by the home, meaning that if the borrower fails to make the necessary payments, they risk losing the property. If the loan has not been paid off when the house is sold, the loan balance must be paid in addition to the original mortgage.
A cash-out refinance is a special type of mortgage refinancing. People often choose to refinance their mortgages because they want a more favorable rate of interest or better conditions. In the case of cash-out refinance, the homeowner is able to receive a lump-sum payout from the equity in the home.
With a cash-out refinance, the money can be used for any purpose, such as home improvements, paying off debt, or paying for another large expense.
Like any other new mortgage, cash-out refinance involves closing costs and appraisal fees. These tend to be lower than those associated with buying a new house.
Refinancing to access cash usually only makes sense if the homeowners can get a reduced rate of interest, as they will end up paying more in interest as the loan amount will be larger.
In other words, it is important to ensure that any cash-out mortgage refinance is a worthwhile decision. If the refinance is at a good rate, and the money will be used to fund a substantial home renovation, it can be a wise choice. This is because you will benefit from the lower interest rate, while also reinvesting cash into the house, potentially increasing its value.
However, keep in mind that a cash-out refinancing may also mean increased monthly mortgage payments, so if the goal is increasing your monthly cash flow, be sure to explore all your options.
Another option to consider for those who want to stay in their home is the Home Equity Conversion Mortgage (HECM), also known as a reverse mortgage.
This federally backed mortgage loan provides older homeowners with access to their home’s equity by converting it into cash. A reverse mortgage will pay off your current mortgage, if you still have one, which means that it also eliminates the monthly mortgage payments.
For the remaining funds, borrowers have the option to receive the money as a lump sum payment, a line of credit, monthly payments, or a combination of the three. Homeowners don’t need to pay taxes on it since it’s considered a loan and not income.
There are no restrictions as to how this money is used — the choice belongs entirely with homeowners.
To qualify, at least one homeowner must be at 62 years old, the home must be the primary residence, the home needs to be in good condition, and there needs to be substantial equity in the home.
Homeowners must continue to pay the property taxes, homeowners insurance, and maintain the home.
Reverse Mortgage for Purchase (HECM for Purchase)
If you like the idea of a reverse mortgage, but you would like to relocate, you may want to consider a reverse mortgage for purchase, also called a HECM for purchase.
A reverse mortgage for purchase allows those who are at least 62 years old to purchase a home that is partially financed by a reverse mortgage. Borrowers will need to put down a significant down payment, typically a minimum of 50%. In most cases, homeowners use the proceeds from their previous home to fund the large down payment.
This option allows borrowers to move into a new home without having a monthly mortgage payment.
However, they still need to comply with the reverse mortgage loan obligations, such as paying the property taxes, insurance, upkeep costs, and any applicable fees, like HOA dues.
If this option interests you, we recommend that you find a reverse mortgage loan officer who specializes in HECM for purchase loans.
Bottom Line: The Good News
The economy is always going to bring uncertainties. The good news about those who have home equity to work with is that they have options. The challenge may be figuring out which option is right for you.
If you are interested in a reverse mortgage or HECM for purchase, check out our top recommended lenders here.
If you are interested in one of the other loan options, these lenders may be able to provide you with the solution you are looking for.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.