How to Use Home Equity in Retirement

Home equity represents the portion of your home’s value that you own outright, calculated as the difference between the home’s current market value and the outstanding mortgage balance. This accumulated wealth can become a significant financial resource during retirement. Accessing home equity can provide funds to supplement income, cover unexpected expenses, or support desired lifestyle needs. Understanding the various methods to tap into this asset is an important step in retirement planning.

Accessing Equity Through Reverse Mortgages

A Home Equity Conversion Mortgage (HECM) is a type of reverse mortgage insured by the Federal Housing Administration (FHA), allowing homeowners to convert a portion of their home equity into cash. Unlike traditional mortgages, HECMs do not require monthly mortgage payments, and the homeowner retains the title to their property. The loan becomes due and payable when the last borrower permanently leaves the home, whether by selling, moving out, or passing away.

To qualify for an HECM, the homeowner must be at least 62 years old and occupy the property as their primary residence. The home must either be owned outright or have a low enough mortgage balance that can be paid off using the HECM proceeds at closing. Mandatory counseling with a U.S. Department of Housing and Urban Development (HUD)-approved counselor is required. A financial assessment also evaluates the borrower’s ability to meet ongoing property charges like taxes, insurance, and maintenance.

Funds from an HECM can be received in several ways. Options include a single lump sum payment, fixed monthly payments for a set period (term payments), or for as long as one lives in the home (tenure payments). Borrowers can also establish a line of credit or choose a combination of these disbursement methods. The amount available for withdrawal depends on factors such as the age of the youngest borrower, current interest rates, and the home’s appraised value, up to the FHA’s HECM mortgage limit, which is $1,209,750 for 2025.

Various costs are associated with an HECM, including an origination fee, capped at 2% of the first $200,000 of the home’s value and 1% of the remaining value, up to a maximum of $6,000. Mortgage Insurance Premiums (MIP) are also charged, consisting of an upfront premium typically 2% of the home’s value, and an annual premium of 0.5% of the outstanding loan balance. Other closing costs, similar to those for a traditional mortgage, cover items like appraisals, title insurance, and recording fees. Even without monthly mortgage payments, homeowners are responsible for continuing to pay property taxes, homeowner’s insurance, and maintaining the home in good condition.

The HECM application process involves several steps. Following the mandatory counseling session, an appraisal of the home is conducted. The lender then performs an underwriting review. Once approved, the loan proceeds are disbursed after the closing process.

Leveraging Equity with Home Equity Loans and Lines of Credit

Home equity loans (HELs) and home equity lines of credit (HELOCs) are two common ways to borrow against home equity. A home equity loan provides a lump sum of money, functioning as a second mortgage on the property. This type of loan typically features a fixed interest rate and requires fixed monthly payments over a set repayment term.

A Home Equity Line of Credit (HELOC), in contrast, operates like a revolving line of credit, similar to a credit card. Borrowers can access funds as needed, up to an approved credit limit, and only pay interest on the amount borrowed. HELOCs generally have variable interest rates, meaning the rate can fluctuate with market conditions, often tied to a benchmark like the prime rate.

HELOCs are structured with two main phases: a draw period and a repayment period. The draw period, typically lasting about 10 years, allows the borrower to access funds and often requires only interest-only payments on the outstanding balance. Once the draw period ends, the loan transitions into the repayment period, which can last 10 to 20 years, during which principal and interest payments are required. The payment amount can significantly increase during the repayment phase as principal payments begin.

Eligibility for both home equity loans and HELOCs depends on several factors, including the homeowner’s credit score, debt-to-income (DTI) ratio, and the amount of equity in the home. Lenders typically look for a credit score of 620 or higher, with scores above 700 often qualifying for more favorable rates. The DTI ratio, which compares monthly debt payments to gross monthly income, is generally preferred to be under 43%, though some lenders may accept up to 50%. Lenders also require a certain percentage of equity to remain in the home after the loan, typically allowing borrowing up to 80% to 90% of the home’s value including the first mortgage.

The application process for HELs and HELOCs involves submitting a formal application. Borrowers typically provide financial documentation, including proof of income, bank statements, and details about existing debts. A credit check is performed, and an appraisal of the home is usually required. The application then undergoes an underwriting review before final approval and closing.

Converting Equity by Selling Your Home

Selling a home is a direct method to convert home equity into liquid cash for retirement. This approach allows homeowners to access the entire net equity, which is the sale price minus any outstanding mortgage balance and selling costs. Motivations for selling a home in retirement often include reducing housing expenses, relocating to a more suitable environment, or freeing up capital for other investments or living costs.

Downsizing is a common strategy, involving a move to a smaller, less expensive home or transitioning to a rental property. This move can significantly lower ongoing housing-related financial burdens, such as property taxes, insurance, utilities, and maintenance. The procedural steps for selling a home typically involve preparing the property for sale. Following preparation, the home is listed and shown to prospective buyers.

Once offers are received, negotiations take place regarding the sale price and terms. Upon agreement, the transaction proceeds to closing. Various costs are incurred when selling a home, including real estate commissions, which commonly range from 5% to 6% of the sale price. Additional closing costs, such as title insurance, transfer taxes, and attorney fees, can add another 2% to 5% of the sale price. Moving expenses are also a consideration.

From a tax perspective, selling a primary residence can offer significant capital gains exclusions. Single filers may exclude up to $250,000 of capital gains, while married couples filing jointly can exclude up to $500,000. To qualify for this exclusion, the homeowner must have owned and lived in the property as their main home for at least two of the five years preceding the sale. After the sale, new housing solutions can include purchasing a smaller home, renting an apartment or house, or moving into a senior living community.