Investing for Retirement with Your Home

The huge gains in the housing market in recent years (before the market tightened, of course and housing plummeted) gave inspiration to many home owners as to a better way to save for retirement.  Rapid housing appreciation made it possible to turn a $20,000.00 down payment into a $100,000.00 plus capital gain.  Why stick your money in boring savings accounts when you can invest for retirement in a place that has real value – your home!

But is investing in a large home a realistic strategy for retirement savings?  Many argue that it is, but others find many problems with the assumptions made by those encouraging this form of “savings.”

Retiring with Your Home

The basic plan for those planning on retiring thanks to their home value is to buy a very expensive home using as much as they can afford with a very large home loan.  For example, rather than staying in a $300,000.00 house, they opt for the $600,000.00 home using most of the money they would otherwise be saving for vacations or furniture or other living expenses.  Then, when retirement comes around, they simply sell that now appreciated million dollar home, buy another $400,000 one and live comfortably on the equity.  For some people, this strategy worked well…for awhile.  Instead of buying an affordable home, these investors took out a large mortgage to buy a home they could just barely afford.  The large mortgage payment made for belt tightening in other parts of the family budget but housing appreciation and the power of leverage paid off.

The leverage is working in more than one way.  First, homes can be purchased with a very small down payment relative to the size of the asset.  A $25,000.00 down payment on a $250,000.00 home is more leverage than can be found in just about any other asset class available for an individual.  While some home owners may be overly concerned about a large monthly mortgage payment, the power of leverage can lead significant financial gains relative to the value of the investment.  For instance should the investment increase by 15% that is not a 15% return on the $25,000.00 down payment but a 15% return on the $250,000.00 home value which is equivalent to a dollar return of $28,750.00 or a 115% return on the $25,000.00 down payment.

In addition there a variety tax benefits for home ownership.  Real estate taxes are generally tax deductible as is mortgage interest paid.  And while the mortgage interest is by and large tax deductible the mortgage rates are also typically the best interest rate available for consumer borrowing.  Mortgage rates are almost always lower than car loan rates, personal loan rates, credit cards and most all forms of borrowing accessible to an individual.

Pros of the Real Estate Plan

With a bird’s eye view this plan looks fantastic.  Real estate is touted as an excellent investment and with the returns we’ve been seeing in recent years on homes, you can expect your home to increase tremendously over the next twenty or thirty years.  The problems with the plan come as you begin to drill down into the details.

Problems with the Real Estate Plan

The bare bones plan of selling expensive real estate and living on the proceeds is more than adequate, it’s attractive to many buyers – especially those who would greatly enjoy living in a larger home for the next thirty years.  But when the yield from the plan is compared to the earnings from more traditional savings, the computations begin to break down.

The housing market has been booming for the past few years.  It is beginning to cool, but rates of return are still high in many parts of the country.  This is why many people are shocked to discover that historically houses only truly appreciate at 2% above inflation over the course of twenty or thirty years.  That’s slightly less than a treasury notes, one of the safest forms of long-term investment.

That million dollar house will be worth $1.8 million after thirty years.  When you sell it, you won’t move back into a $400,000 house – those homes appreciated, too.  You’ll be moving into a $700,000 house leaving you $1.1 million.  A nice piece of change, but that’s before you start considering fees and commissions.  That end results also doesn’t include the maintenance and taxes you’ve been paying on your home for the past thirty years.

By comparison, if you stuck with your $400,000 house and simply paid down the mortgage loan over those thirty years while sticking that extra money into treasury notes (which is a very conservative assumption), you would stand to earn $2 million in today’s dollars – almost twice the result of the home plan.  And if you invested that money in real portfolios including stocks and a variety of other instruments, you’d be looking at up to three times the return or $3 million.

The biggest problem is simply the uncertainty of the future value of real estate.  If an individual invests in a $750,000.00 home that has a mortgage that is barely affordable, a concern arises on what to do should the value of the home remain stagnant.  Now the mortgage payment is crippling the home owner’s lifestyle and their assets are not diversified since the majority of their funds are tied up in a house that is not appreciating and is now potentially very difficult to sell.

Savings for retirement using your home is a plan that can work.  The trouble is it simply doesn’t work well enough to justify your expensive new home to anyone but yourself.  If you want to consider such a plan be sure to study the numbers.  Analyze your budget and the cost of the home including the mortgage payment and cost of maintaining the property.  Run the figures through a mortgage calculator and look at all the available options before leaping into this questionable retirement strategy.