How to View Your Home Within Your Financial Plan, Episode #44
For most people, your home is the single biggest purchase you’ll ever make and is one of your most valuable assets. However, despite it being so important, not everyone knows how to look at it within the context of their overall financial life and plan. In this episode, we start out by explaining how your home works as an investment and source of wealth, and how it grows over time. We then discuss how to think about converting that value into something you can actually use (if you want to). Finally, we wrap up by talking about how to view your home as part of your overall financial and retirement plan, some of the different roles it can play, and why each might be attractive to you.
Outline of this episode
- How to think about a home as an investment [1:20]
- How the value of that investment changes over time [3:41]
- Capitalizing on your home equity [8:24]
- How to build your home into your retirement plan [12:00]
- The recap [17:02]
Your home is an investment whose value increases over time
When thinking about your home as a financial asset, the most important thing to focus on is the value of your home equity. Home equity is the difference between the value of your home and the amount of money left on your mortgage. In other words, equity is similar to net worth in that it's the difference between what you own and what you owe, and is therefore the money that's truly yours and is available to you.
The value of your home as a financial asset grows over time due to two factors. One is that as you pay down your mortgage, you owe less money, and that difference between what you own and owe increases. The second is that home prices increase over time (although the rate depends on geography and time period). Because of these dynamics, the value of your home equity grows over time and for most people, it becomes a significant financial asset, especially as you approach retirement.
Capitalizing on your home
Having equity that increases over time looks great on paper, but it's different than being able to readily tap into it or to capitalize on that equity. There are different ways that you can take advantage of your home equity, including selling the home, doing a cash-out mortgage refinance, and also less common methods such as a reverse mortgage if you're over age 62.
One obvious way to tap into your equity is to sell your home. However, you always need a place to live so most commonly people who are selling their home to tap into the equity are planning to either downsize homes, rent, or move to a long-term care facility.
Another option is to do a cash-out refinance. It's worth noting that there are fees associated with doing a cash-out refinance and lenders have requirements for how much of the home equity you're able to take out, however it's an easy way to access the equity in your home.
Why we don’t consider your home when planning for retirement
We prefer not using home equity to fund your retirement. The reason we like this conservative approach is that it provides more margin of safety with retirement projections while at the same time providing flexibility and options in other parts of the retirement plan, such as leaving a legacy to heirs or having a cushion to protect against long-term care risks.
If you plan well and don’t end up using the money from your home in retirement, then homes are a very tax-efficient way to give money to heirs. When you pass away, your heirs receive what's called a step-up in basis for your home. This is where the cost of the home for tax purposes is adjusted upward to its market value when you die. If your heirs turn around and immediately sell the home they won't owe taxes on it since they'll be selling the home for the same amount as their cost, as defined by the IRS. That means no gains to pay taxes on. This can be pretty significant, especially if you have owned the home for a long time.
Resources & People Mentioned
- Podcast episode #33: What to Know About Mortgages and Refinancing
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup
Connect With Trent and Andrew
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