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Home Equity Tapped Out?

Possibilities include downsizing your home, selling assets, working longer and taking out a reverse mortgage. Each has its challenges and risks…

The safety net is almost gone, the nest egg is cracking.

Many Americans have recently found themselves changing their retirement plans after losing a substantial amount of home equity as the housing market and the overall U.S. economy struggle. These folks face years of living on fixed incomes from sources such as pensions, 401(k)s, individual retirement accounts and Social Security but don’t have the time to recover their losses.

Homeowners who tapped their home equity find themselves with no more funds to extract. Some have been laid off, relinquished their home in a foreclosure or lost pensions after their employers’ business failed. Ideas of a comfortable retirement full of relaxation and travel have been abandoned.

The good news is that about 30% of homeowners have no mortgage at all. So even though their properties are probably worth less now than a few years ago, these people can tap into that equity cushion if necessary.

The bad news, however, is that about 1 in 6 with a mortgage now owe the bank more than their homes are worth, according to Moody’s Most of these are property owners who purchased their homes within the last few years or refinanced their properties and siphoned off too much equity.

With that in mind, it’s time for Americans to explore options other than relying on home equity, especially if they have no retirement investments or savings. These include downsizing their home, selling assets, postponing retirement by working longer and signing up for a reverse mortgage. Each option has its challenges and risks.

Ken King, 61, once planned to retire in his early to mid-60s. The value of his home has dropped $70,000, so he has scrapped plans to sell the five-bedroom house and downsize, because the savings won’t be substantial enough to make it a smart move. He’s also seen his 401(k) lose value.

King, a credit counselor in Sheboygan, Wis., said he probably would work into his early 70s to compensate.

“This is something I wouldn’t have considered even thinking about 1 1/2 years ago,” said King, adding that priorities have changed this year among those he counsels.

“Now we’re talking to people about what they have to do to survive,” he said.

King’s own strategy of working longer is a growing trend. AARP reported in April that almost 1 in 4 people ages 45 to 54 planned to delay retirement, with 1 in 5 people ages 55 to 64 thinking the same.

Staying on the job has benefits besides a paycheck. Employment is often a requisite in qualifying for mortgage refinancing, a good option for those with equity and good credit because rates have fallen to historic lows. But refinancing becomes almost impossible for seniors on fixed incomes with no job or equity.

The scenario becomes more difficult if the senior has stopped working and wants to return to the workforce, especially as health issues crop up and competition for jobs increases, said George Moschis, director of the Center for Mature Consumer Studies at Georgia State University.

By working later in life, pre-retirees also can consider putting off collecting Social Security, a strategy that could lead to higher monthly payouts once they do start collecting.

Finding a smaller and less expensive home has long been relied upon to bolster retirement budgets. Ideally, profits from the sale of a larger home can be used to buy the smaller home with cash, with no mortgage, and the homeowner can pocket the rest. But the current environment of falling home values and tight credit has made selling a more difficult proposition in many markets.

Another way to shore up retirement accounts is selling off assets, including cars, second homes, stocks and expensive jewelry.

Options such as working longer and selling assets are not as risky as reverse mortgages or selling life insurance policies, two instruments marketed as ways to free up retirement cash.

A reverse mortgage allows homeowners to borrow from the home’s equity in a lump sum, line of credit or regular payments, while not having to pay a monthly mortgage. The homeowner retains title and must pay insurance and property taxes while living in the house.

The loan and fees are due once all parties listed on the deed die or the home is vacant for 12 straight months. The home is usually sold, and the proceeds from the sale are used to pay off the loan, plus interest and fees that can be as much as 8% of the loan.

Reverse mortgages have become more attractive because the government raised lending limits to $417,000 last year, noted Eric Bachman, chief executive of Golden Gateway Financial in Oakland. But as equity drops, so does the amount one can borrow in a reverse mortgage, so timing is key.

However, experts such as AARP financial “ambassador” Jonathan Pond say reverse mortgages should be something of a last resort, because of high fees and the complicated nature of the loans. Reverse mortgages also mean the home will probably be sold at the end of the loan, mainly because the homeowner, or an heir, will want cash to pay off the mortgage.

Education is key, because of fears that reverse mortgage complexities could be used to trick seniors. The American Assn. of Residential Mortgage Regulators and the Conference of State Bank Supervisors established guidelines to be used starting early this year to review lenders and brokers selling reverse mortgages to seniors.

The guidelines are meant to guard consumers against fraud and abuse, “such as the simultaneous sale of unsuitable investments or deceptive sales practices,” according to a December news release from the groups.

An alternative for desperate seniors is to sell their life insurance policy, either back to their insurer or on the private market.

This move, called a “life settlement,” is risky because it leaves consumers without the life insurance and financial security they had once desired to leave behind for loved ones.