I recently read JL Collins new book How I Lost Money in Real Estate Before It Was Fashionable. I also updated the most popular article on this site, Darrow’s Renting vs. Buying: The True Cost of Home Ownership. Each makes a compelling case for renting.
Still many of you, like me, will decide owning your home is the right decision. Often the final deciding factors are emotional rather than financial.
That does not mean home ownership doesn’t have important financial benefits. Let’s consider the financial advantages and planning opportunities owning your home provides.
Locking In Housing Expenses Provides Predictability
The first advantage of home ownership is true whether you own your home outright or carry a fixed rate fully amortizing mortgage. You control exactly what you will spend on mortgage and interest payments for the term of the mortgage. If you choose to pay the mortgage off, you eliminate these expenses completely.
Housing represents the largest expense for most households. Fixing or eliminating your housing expense can provide a psychological benefit.
With so many uncertainties baked into any retirement scenario, having certainty over this large expense can be comforting. It also enables you to take risks in other areas.
Home Ownership is an Inflation Hedge
Having housing costs fixed also offers a tremendous inflation hedge. Those who rent need to prepare for the potential of rent increasing at or greater than the rate of inflation.
At times like these, controlling (or eliminating) such a large expense as mortgage or rent payment is a massive benefit. This is especially true for a retiree who won’t benefit from inflating wages and instead must produce income from investments.
Tax Advantages of Home Ownership
Discussions of tax benefits of home ownership often focus on the direct benefits of being able to deduct mortgage interest and real estate taxes at your marginal tax rate. Even in our situation with a paid off mortgage and not enough total deductions to benefit from itemizing property taxes, we recognize secondary tax benefits of home ownership.
Owning your home outright enables you to live well without needing much income. A rent or mortgage payment is the largest expense in most households.
Eliminating that expense reduces the amount of income you need to live well. Needing less annual income enables you to pay less income tax at lower marginal tax rates.
Living well for less introduces another often overlooked secondary tax benefit. You can optimize Affordable Care Act (ACA) tax credits. These credits are based on household income (MAGI to be technically correct).
The cost of an identical health insurance plan on the open marketplace can vary by tens of thousands of dollars per year between those who can optimize subsidies by limiting their income and those paying the full cost because they can’t. Paying off a mortgage is a powerful lever to pull to lower the income you need to live for those who can benefit from ACA premium subsidies.
Another strategy to lower your lifetime tax burden is to utilize a Roth IRA conversion ladder. This requires rolling over a targeted amount of money from tax-deferred investments to Roth IRA accounts each year. Needing less income to support your spending gives more space in favorable marginal tax brackets to do these conversions.
Related: Early Retirement Tax Planning 101
Eliminating mortgage and rent payments helps with all of these tax minimization strategies.
Moving to Create Income
One argument against home ownership is that it ties up capital that then can’t be used to fund your lifestyle. If you’re willing to move to free up some of that capital to fund your retirement, that’s not necessarily true.
Owning a home with the plan to sell it later provides options that can enable you to retire sooner. Home ownership can also provide a contingency plan if you need to free up capital in retirement.
Some people think developing a high savings rate to enable financial independence and early retirement is impossible for many people who live in high cost of living areas. This can be a legitimate challenge during your working years.
But there is no rule that says you must stay in a high cost of living area when you no longer need to earn an income. Utilizing geoarbitrage, moving from a higher cost of living area to a lower cost area where your dollars stretch further, provides a way to free up capital tied up in a home. It can simultaneously improve lifestyle.
I recently discussed this scenario with friends who live and work in the high cost-of-living Washington D.C. metro area. They are contemplating early retirement and are considering different variables that could impact their decision. If they sell their current home and buy something comparable in our area they would pocket about $500,000.
Assuming a 3-5% safe withdrawal rate, that $500,000 would create an annual income stream of $15,000-$25,000. This would also significantly decrease their spending by lowering property taxes and cutting the amount they currently spend on travel.
You may not want to move to a lower cost area. Family connections, friendships developed over working years, or other lifestyle considerations could make staying in your current location attractive. A similar strategy could be used with downsizing your home to free up capital.
There are various reasons it may make sense to own a larger home during your working years. With kids at home, having extra space can be a luxury. A home gym can provide convenience and enable a healthier lifestyle. Many people keep a home office.
As your stage in life changes, so do housing needs. Things that at one point were luxuries and conveniences can become burdens to maintain and add unnecessary costs.
Selling a home and downsizing to a lower cost home can provide a sudden infusion of cash. This decision can also come with ongoing economic benefits in the form of lower taxes, maintenance expenses, and utility bills.
Making one decision to use your house to create income through geoarbitrage or downsizing can completely change your retirement options.
Staying and Creating Income
Some people may be set on staying in their home for life. Home ownership provides several options to fund your retirement while providing diversification away from stocks and bonds.
Creating Rental Income
Many people dream of traveling in retirement. To some, a home is seen as an anchor that weighs down these dreams. You still have to pay expenses including property taxes, utilities, and possibly having to someone to maintain the property while you travel.
Times are changing. Services like Vrbo and Airbnb make it easier than ever to use your home as a source of income when you’re not using it for your own shelter. Homeowners now use primary residences to produce income in ways that would have been challenging, if not impossible, just 5-10 years ago. Excellent online resources are available to teach you how to rent your home while you go traveling.
For others who don’t want to downsize, these same services give the option to use your primary residence to create income by renting out areas of your home that you’re not currently using. I’ve written how we designed our home ownership to retire sooner utilizing this approach.
For full disclosure, we have never made a penny using our home as a short-term rental. But having the option to do so provides another contingency to our early retirement planning.
Turning Equity Into Income
Another option to create income to meet your spending needs is to consider financial products to tap the equity in your home. These strategies will have costs associated and can introduce risk to your financial plans, so you should consider them carefully.
But for the right person and circumstances, they can be valuable. So they should not be ignored.
Home Equity Lines of Credit (HELOC)
I am debt averse. I never considered a home equity line of credit or home equity loan until a few years ago. We decided to buy our current residence and use it as a rental until we sold our former one.
A real estate investor friend suggested using a home equity loan against our former residence to buy our current one rather than getting a mortgage. I was amazed at the favorable terms we were able to obtain on a home equity loan. So we acted on his suggestion.
This opened my eyes to other ways it’s possible to use a home for your shelter and simultaneously use the equity to provide for your spending needs.
One option is to use a HELOC as an emergency fund. This can come with origination fees and annual expenses which should be considered. This strategy can also bring increased risk to your financial plan and enable unwise spending decisions if not used carefully.
I’ve also heard anecdotally that credit lines were cut or canceled in times of tightening credit during economic downturns. This is exactly when you’d be most likely to need an emergency fund. So know exactly what you’re getting into if you consider this strategy.
Still, for the right person this can be a viable and attractive option to use the equity in your home.
Another option that recently came onto my radar is a reverse mortgage. Respected retirement researcher Wade Pfau advises retirees to consider reverse mortgages as part of their retirement plans. He wrote an entire book on using reverse mortgages to secure your retirement.
Other interesting research from the journal of financial planning shows that using a reverse mortgage closer to the eligibility age of 62, rather than as a last resort, can increase retirement income and security in particular circumstances.
The primary benefit of a reverse mortgage seems to be the ability to create income from your home during a bear market early in retirement. This gives your portfolio time to recover, reducing sequence of returns risk.
Using Your Home as Long Term Care Insurance
Home ownership can also factor into the complex decision around buying long-term care (LTC) insurance.
According to the website MedicareInteractive.org: “Home health care includes a wide range of health and social services delivered in your home to treat illness or injury. Services covered by Medicare’s home health benefit include intermittent skilled nursing care, therapy, and care provided by a home health aide. Depending on the circumstances, home health care will be covered by either Part A or Part B.”
However, according to Medicare.gov: “Medicare doesn’t cover long-term care (also called custodial care), if that’s the only care you need. . . You pay 100% for non-covered services, including most long-term care.”
A reasonable strategy is to stay in your home and receive home based services which are covered by Medicare as long as possible.
Owning your home can act as LTC insurance. If the time comes that you can no longer live in the home without custodial care, then you can sell it to fund ongoing expenses. Simultaneously, you maintain the upside of keeping the home while not having paid LTC insurance premiums if you never need LTC.
This strategy does have challenges as well. It may be difficult, and almost certainly stressful, to try to sell a home quickly at the time that LTC is needed. This could also be complicated if only one half of a married couple needs LTC and the other still needs a place to stay.
Do The Financial Advantages of Home Ownership Outweigh the Costs?
There is no one size fits all answer to this question. There are many opportunities to use home ownership as part of an overall financial and retirement plan.
My goal with this blog post is to highlight some options. Think about which makes sense for your situation. You can’t use all of these strategies. For example, you wouldn’t want to take equity out of your home if you are banking on being able to use the equity to fund your LTC needs.
My own thinking about home ownership, as with most things in life, is constantly evolving as I learn. But having been a homeowner for most of my adult life, I have no regrets looking back. Considering the options and benefits home ownership provides, I plan to remain a homeowner for the foreseeable future.
How do you factor home ownership into your investment and retirement plans? Have you thought of ideas I’ve missed? Have you utilized any of these strategies to your advantage, or found they didn’t work well for you? Share your thoughts and experiences in the comments below.
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to email@example.com. Financial planning inquiries can be sent to firstname.lastname@example.org]
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