How your home can help you ‘renovate’ your finances

After years, or even decades, in a family home, it might seem unthinkable to say goodbye to this repository of memories. Your house could feel like a member of the family, a participant in all of those holiday gatherings, raucous playdates, laughter-filled meals, and to sell it for mere financial reasons could seem like a betrayal of sorts. But once the kids have grown up and moved on, that same house or apartment ― and the equity you may have built up in it ― could provide the means for you to help realize your goals as you transition to the next phase on your journey.

Clearly, downsizing from an empty nest to a smaller, more affordable home can be a smart financial decision. But it can be a very tough one emotionally. “People might know intellectually that their home is a financial asset, but they think of it in emotional terms — as the place where they raised their kids, where they want to grow old,” says Bill Hunter, director of Institutional Retirement Wellness & Planning, Retirement & Personal Wealth Solutions at Bank of America. Still, Hunter adds that ignoring an asset that may be worth hundreds of thousands of dollars would be a mistake. “It’s critical that you examine all the financial resources you can bring to bear when figuring out a plan for pursuing your goals,” agrees Lorna Sabbia, head of Retirement & Personal Wealth Solutions at Bank of America.

So what role should your home play in your overall financial picture? And how can you take advantage of the home equity you’ve built up?

Is homeownership a good investment?

Of course you’re not guaranteed a huge payout when you sell your residence. How much equity you have in your home is largely dependent on how long you’ve owned it, how large your initial down payment was and how high home prices are in your area at any given time.

“The housing market has staged an impressive recovery following a brief downturn as a result of the coronavirus shock,” says Michelle Meyer, head of U.S. Economics at Bank of America Global Research. “Home sales have been climbing higher, running in excess of levels reached prior to the pandemic. With lean inventory, builders are ramping up construction, but the strong increase in demand has still resulted in higher price appreciation. Over the longer run, it’s likely home prices will settle at an annual growth rate of 3%–4% per year, matching the rate of income growth.” “A diversified portfolio of stocks and bonds has traditionally returned considerably more,” says Matthew Diczok, a fixed-income strategist at Bank of America. But surprisingly, 44% of Americans don’t even own stock.¹ The typical homeowner usually dedicates 20%‒30% of their gross income to their mortgage payment, and over the years those steady payments can really add up.

Living in your biggest asset

“Your home might end up being the biggest asset on your balance sheet,” Diczok says. The average American has a net worth of just under $98,000, but according to U.S. Census Bureau data, nearly 70% of that is home equity.² “That’s why it’s critical to look at how your home’s value fits in with your other investments,” he adds.

From an investing standpoint, that can mean a number of things. “Some people,” Diczok says, “may feel comfortable taking on a little more risk in the way they approach the markets, knowing that they have a portion of their net worth invested in a relatively stable asset — their home.” Others may see an advantage in being able to draw on their home equity to cover emergency expenses, rather than selling off shares in their portfolio. That way they don’t miss out on any potential market growth. If the expense is large, however, taking out a home equity loan or line of credit could put your home at risk — if you can’t pay off the loan, you could lose your house.

3 ways to tap your home equity

You don’t have to sell your home to put your equity to work for you, of course. “There are three main ways to tap your home’s value while you’re still living there,” says Marie Imundo, director, Wealth Management Mortgage Strategy and Execution, Bank of America. They are a home equity line of credit (better known as a HELOC), a home equity loan (sometimes referred to as a HELOAN) and a cash-out refinance. “The best choice for you will depend on interest rates and what you need the money for.”

With a cash-out refinance, you get a new loan, ideally at a lower rate, to pay off your existing mortgage, plus some additional money from your home equity, which you might use to cover a home renovation project, or to help you manage any number of other current expenses. Cashing out your home equity is an option you might want to consider if you have a first mortgage on which you’re paying a higher interest rate than is currently available. “Keep in mind, though,” says Imundo, “that your new loan balance will be higher than your current loan, leaving you with a larger mortgage, typically a higher monthly payment (depending on available interest rates) and the potential to pay more interest over the life of the loan.”

“What if your current mortgage rate is already low? Then you may want to consider tapping into home equity through a home equity loan or a line of credit,” Imundo says. The difference between the two? Home equity loans are for a fixed amount and are often made at fixed rates of interest. Home equity lines of credit give you access to a set amount of credit, but you don’t have to use it all or all at the same time. You can tap that credit — and pay it off — as you need it during the “draw period,” or the term of the loan. Home equity lines of credit are often made at variable rates of interest, though you can find fixed-rate options.

A home equity loan may make the most sense for a fixed expense — say college tuition that you might want to pay off over a number of years — while generally a home equity line of credit is used for recurring items, like home renovations, which may require frequent and varied withdrawal amounts.

One thing you should never consider using your home equity for, notes Imundo, is investing. Stocks, bonds and mutual funds fluctuate in value, and you wouldn’t want to risk losing your home if the return on your investments is not sufficient to cover a new mortgage, loan or line of credit. If the value of your investments were to decrease, you might need to sell them to protect your home and limit further losses.

When the tuition bill comes due…

Stephen Stabile, a New York City-based Merrill managing director and financial advisor, recalls how he once provided access to Bank of America to help a client finance his daughter’s $50,000 annual college tab with a HELOC. The client originally had planned to pay the tuition by selling stocks, but this would have subjected him to capital gains taxes and forced him to reduce his stock holdings at a time when the market was appreciating rapidly. Because the client intended to sell his $2 million home and downsize once his daughter graduated, the long-term impact of rising interest rates on the cost of a variable rate HELOC likely was not going to be a significant consideration at that point in time.

“In the end, all of the pieces fit together perfectly,” Stabile says. “Of course, another solution may be more appropriate for a different family. There are no one-size-fits-all answers in wealth management.”

The hidden benefits of downsizing

Many retirees decide to downsize in retirement, and doing so comes with potential added benefits — you can cut many home-related expenses. The Center for Retirement Research at Boston College found that empty-nesters were spending 30% of their income on property taxes, insurance, maintenance and utilities.³

The question for downsizers then becomes what to do with all of the unleashed capital. “There’s no single right answer,” says Imundo. “You and your advisor can look at all of the options to help figure out what might work best for what you want to achieve.” Then you can move on to focus again on the people and things that matter most to you ― and create new memories, perhaps in new places.