By Brian McCarver, CFP®, CIMA®
Many consider owning a large home and lots of land surrounded, of course, by a white picket fence as part of the “American dream.” However, how financially realistic is that dream in today’s competitive housing market? People forget when buying a house that the cost to own and maintain it directly impacts your future financial decisions, especially for those nearing retirement age.
On average, home equity comprises over 50% of net worth for people between ages 55 and 59. Thus, about half of their net worth is available to fund retirement and other expenses, a seemingly challenging task. It becomes more so when you consider the costs to occupy and maintain a home within that limited budget.
When contemplating how to buy a nice house while still preparing for or saving for retirement, here are a few important financial implications to consider.
Consideration 1: Before Retirement, the Cost of Your House Can Distract from Saving for Your Future
A large home might seem appealing now, but it won’t be so wonderful when you’re still working at age 70 because you can’t afford to retire. Unfortunately for many, the cost of their homes can distract them from saving early for retirement.
Put differently, money spent on a house is money not spent on something else, and usually that something else is retirement savings. This is not a problem when house costs are low enough you still have plenty of funds to put toward future goals. However, when the costs rise so high there’s hardly any money left over, things get a bit sticky.
As a rule of thumb, a retirement savings rate of 10-15% of current total household wages (including employer contributions) is ideal. Contributing much less than 10% could mean you’ll need to work longer before retirement. When balancing this contribution recommendation and buying a home, people in the pre-retirement phase of life should focus on that contribution goal and then an affordable house after the savings target has been met.
Unfortunately, many people underestimate the total costs associated with buying a home and pay more over time than they originally expected, again leaving a less-than-ideal amount left to go toward retirement.
When buying a home and setting a realistic budget, keep your retirement in the back of your mind as it is still a crucial financial responsibility.
Consideration 2: The Value of Your House As an Asset on Your Balance Sheet Cannot Be Used to Fund Retirement Expenses
Congrats! You’ve made it to retirement! Unfortunately, you have not planned accordingly, and your liquid assets are insufficient to support your desired retirement lifestyle. So, you consider turning to your home to pay your retirement expenses. But, because your house is not liquid, your money is essentially stuck until you decide to sell, which isn’t helpful when you have present bills to pay.
The best way to mitigate this is not to own too much house into retirement. Consider downsizing or moving to a less-expensive area. A reverse mortgage is a consideration in these conditions, but those come with many disadvantages that consumers should research and understand before proceeding. Again, a big house is not a bad thing, but owning a big house when you lack other liquid assets can prove challenging for those who are retired or nearing retirement.
Consideration 3: Owning a House Costs 4-5% of Its Value Annually, Which Can Impact Retirement Affordability
Shelter is one of our basic necessities, but between property taxes, maintenance, repairs and homeowner’s insurance, houses cost an estimated 4-5% of their total value each year. A house that costs $500,000 would require an additional $20,000 to $25,000 each year, whereas a house that only costs $300,000 may only require between $12,000 and $15,000 extra each year. Stated differently, it takes approximately one dollar of investment value to generate the necessary income to own one dollar of home and property value. So, if you retire with that very nice $500,000, set aside $500,000 of your retirement savings just to occupy and operate your residence.
This cost estimation assumes you have a single-family home and no debt on the residence. The percentage would potentially be lower if you are retired and living in a 55+ community, townhome or small house.
Nonetheless, these costs can impact retirement affordability, especially if the homeowner fails to account for them at the time of purchase. It is easy to get consumed by mortgage, maintenance and home improvement costs, yet it is still important to prioritize retirement savings. One way to effectively prepare for this is to factor in yearly expenses when setting your original home budget.
Buying a home is exciting, but buying a home outside of your financial means can be dangerous. The moral of the story is: Don’t neglect your future financial responsibility when buying a home. Here at Stonebridge, our Financial Advisors warn our clients in Harrisburg, Lancaster and beyond to be careful about how much house they own and how the cost of their house could interfere with the steps necessary to retire.
As one of the Directors of Stonebridge Financial Group, Brian’s primary focus is high-net-worth client wealth management and retirement plan consulting. He serves his clients honestly and objectively and works diligently to help them reach their financial goals.