Considerations and Risks of Selling Your Home

Using home equity as a funding source may be an option for many people, but there are considerations and risks:

• Selling your home may mean severing emotional ties, and that the home will no longer be part of your estate to pass on to heirs.
• You'll need replacement housing, which could mean a major downsizing or radical relocation to free sufficient equity.
• A house is no substitute for a diversified retirement portfolio. The housing market is subject to periodic declines and there is significant variability in price trends from region to region.
• What's more, the strong appreciation in home prices that has occurred in many areas in recent years is not indicative of long-term trends. In fact, long-term appreciation rates in most markets have been lower than the returns available from a diversified equity portfolio.

Nonetheless, cashing in on your home does pose potential tax advantages. The federal government allows an exclusion from capital gains tax of up to $250,000 for individuals and $500,000 for joint filers on their principal residence, provided the property has been owner occupied for at least two of the preceding five years. The capital gains exclusion can be taken every two years, but applies only to the sale of a principal residence. If you own income-producing property, you must generally pay tax on the gain when you sell.

If you have potential gain in your principal residence that is significantly above your exclusion amount, you'll want to factor in estate planning considerations. Current federal estate tax rules permit a step up in basis on appreciated assets, allowing heirs to avoid capital gains tax altogether. Keep in mind that estate tax rules are complex and in flux. You should consult with an estate planner before cashing in your home for retirement if you have a significant unrealized gain. For more information, see also the Estate Planning Action Center.

The Reverse Mortgage Option: Is it Right for You?

Another way to tap into home equity is through a reverse mortgage, also known as an equity release or equity conversion mortgage. Reverse mortgages work just like a regular mortgage only in reverse: the bank or lender pays you a monthly amount in exchange for a portion of the equity built up in your primary residence. The older you are and the more equity you have in your house, the higher the loan amount available. Payment periods depend upon the owner's age and the loan is repaid when you leave your home, either through sale or death.

As with forward mortgages, the terms of reverse mortgages vary from lender to lender, with potentially higher closing costs. Like downsizing or relocating, taking on a reverse mortgage also involves non-financial considerations and should be considered along with estate planning priorities.

Reverse Mortgage Considerations

• Reverse mortgages tend to be more costly than traditional loans
• Reverse mortgages may use up all of the equity in a home resulting in fewer assets for the homeowner or their heirs or even the potential loss of the home.
• Origination fees and closing costs may apply.
• Interest on reverse mortgages cannot generally be taken as an income tax deduction until it is actually paid. Typically, interest on these loans is added to the loan balance as it accrues, and is not paid until the loan principal is paid.
• Homeowners remain responsible for housing expenses such as taxes, maintenance, fuel, and insurance.
• Investing reverse mortgage proceeds in other than conservative investments may result in a higher likelihood of losses.