Rising home prices often mean that real estate forms a top-heavy portion of many seniors’ wealth in retirement. This forces some to tap into their home equity in order to pay the bills and overcome their past failure to save.
Until recently, their only choice was a reverse mortgage, a secured loan in which lenders like HomEquity Bank make monthly payments to them, based on the equity that they’ve built up over the years, rather than the other way around.
Related Read: Case Study – Should These Boomers Get a Reverse Mortgage?
Reverse Mortgages An Expensive Option
One major attraction of this arrangement is that the payments you receive aren’t considered taxable income and thus won’t affect your potential government retirement benefits.
A common criticism of reverse mortgages is that they’re expensive, resulting in the view that they should only be used as a last resort. And the certainly are, compared to more common mortgage loans. But the ability to stay in the family home this way is really a bit of a luxury, argue plan sponsors, and having someone else assume some or all of the appreciation risk ought to cost something.
Selling But Not Really Leaving
But what if you could sell out altogether and then lease back your family home, freeing up all that cash and leaving you unexposed to the drop in home values that so many predict?
Although fairly common when it comes to commercial real estate – in those cases, a business sells a building to raise money, and then leases it back from the new buyer, usually with some tax breaks – sale and leaseback arrangements are a fairly new wrinkle in the residential housing market.
Enter Sell ‘n STAY, a new option for older homeowners looking to unlock their home equity by selling it to an investor/buyer and then entering into a lease agreement with the new owner – with you staying on as the tenant.
A Tenant In Your Own Home
The selling price is determined by comparing sales of similar homes in your neighbourhood backed, if you’re smart, by the findings of a certified appraiser, minus the normal commissions and selling costs.
You make the final decision as to the suitability of the landlord who, once your home is sold, will be responsible for paying taxes and any condo fees, as well as repairs and maintenance. You’ll still be responsible for paying utilities, telephone, cable, and renter’s insurance.
While the standard Sell ‘n STAY lease agreement purports to take into account typical landlord and tenant stipulations – i.e., a 10-year lease, which alleviates the concern of you being suddenly ‘kicked out’– you’d be wise to have the document scrutinized by your own lawyer and shaped to your advantage.
How will the two of you handle repairs, for instance? If you’ve been living in the house for decades, your view of appropriate maintenance may be quite different from the new owner’s perspective. Including a possible buy-back may give you some wiggle room here.
Rent Costs Will Rise Over Time
Expect your rent to be something like 5-6 per cent of your home’s sale price, although that will change over time despite any rent controls. In Ontario, for instance, the Residential Tenancies Act stipulates that annual increases can’t exceed 2.5 per cent, even if the CPI is running higher. Keep in mind that your annual rent cost isn’t ever likely to head lower.
On the surface, a sales-leaseback looks like it could be a win-win. Aging homeowners get money to fund their retirement; motivated buyers get a property with a built-in, and suddenly more affluent, tenant.
On the other hand, you become a renter and lose the chance to build more equity in the home with little say over its future. And if the new buyer/landlord gets into financial trouble and needs to pull the plug somehow, you may have little legal recourse to plead your case.
A Home Equity Line Of Credit Is Another Option
If you simply need some extra cash to pay the bills, a home equity line of credit secured against the value of your home is likely a better bet. But these may be less useful for older homeowners since they may have a harder time qualifying without some regular income.
If you see yourself going the HELOC route, set things up well before retirement. Then draw funds only if and as needed. You can use the money to smooth spending in peak years, especially if most of your assets are in registered accounts with built-in tax costs.