Think You Can Retire on the House? Think Again

It's a time-honored California retirement tradition: Sell the house, which has soared in value over the years, move somewhere cheaper and live off the home sale proceeds.

For recent generations of retirees, tapping equity in this way could in many instances more than make up for a lack of other retirement savings, or could amply supplement a traditional pension and Social Security benefits.

But financial planners today warn against counting on your house to bail you out in your retirement years. Uncertain home price appreciation, the rise of home equity mortgages and the logistics of relocating are likely to limit the number of future retirees who will be able to take advantage of this option.

In fact, relocation has never been the most popular option for retirees. Only a small portion "take the money and run," even in California, said demographer William H. Frey of the Milken Institute, who has studied the migration patterns of the elderly in the U.S.

Between 1985 and 1990, for example, about 190,000 of California's 4.2 million residents over age 60 left the state. The emigration was more than offset by the 200,000 or so older immigrants who came to California from other states and foreign countries.

Those who leave California tend to be what Frey calls the "yuppie elderly"--relatively young, affluent, married and in good health. Unusually strong home price appreciation in the 1970s and 1980s probably fueled their exodus, and most wound up in lower-tax states such as Arizona, Nevada, Oregon, Washington or Texas, where real estate prices and living costs were lower, he said.

Frey said there are no solid statistics about how many seniors sold homes and downsized into smaller places in the same city, or moved to less expensive areas within the same state. But it appears that the vast majority remain in the same state, if not in the same house, for the remainder of their lives, Frey said.

"There's a very strong 'aging in place' effect, including in California," Frey said.

In any case, today's workers--at least, those between the ages of 35 and 54--seem unlikely to see the kind of rapid price appreciation that people in previous decades experienced.

Although home values have indeed increased recently, demographics are working against baby boomers. The generation born between 1946 and 1964 has essentially stopped forming new households; most have at least bought their first house, and many have finished "trading up" to larger homes. Moreover, the "baby bust" generation that followed them is smaller. Both trends are expected to create less home-buying demand, although immigration may counteract that somewhat. Many experts say home appreciation over the next two decades is likely to slow to little more than the rate of inflation. A few, such as economist Daniel McFadden of UC Berkeley, argue that home prices will even fall in the next decade, perhaps dramatically, because of declining demand.

Should home prices rise at a rate that equals the historical rate of inflation--about 3% annually for most of this century--the value of a home would more than double over 30 years. But with inflation devaluing the dollar at the same rate, such a nest egg may not go far in retirement. An equivalent investment in stocks, which have historically gained an average of 10% to 11% a year for most of this century, could grow more than 20-fold--more than outpacing inflation.

Even if home appreciation beats those expectations, homeowners have increasingly gotten into the habit of borrowing against their home values to fund current consumption. Financial planners fear the trend could leave future retirees at more financial risk.

Home equity loans have grown from about $7 billion in new loans in 1990 to $55 billion in new loans in 1998. A large chunk of this borrowing goes to pay off credit card debts. Market research firm Brittain Associates Inc. of Atlanta estimates that between 1996 and 1998, Americans converted $26 billion of credit card debt into home equity loans.

Home equity borrowing by itself need not be devastating to a future retiree's financial health. In fact, interest rates on home equity loans are typically lower than those offered by credit card companies, and the interest on the loan may be tax-deductible as well, depending on the borrower's circumstances. But any kind of borrowing reduces the amount of money that will be available in retirement, because cash is going for interest payments rather than being invested for the future.

An even bigger problem lies with homeowners who borrow repeatedly, depleting their retirement prospects along with their equity. The researchers found that most of the 4.2 million Americans who took out home equity loans in the last two years had continued to rack up credit card debt. Only 1.5 million had no credit card balance when the two-year study ended.

Financial planners say a particularly worrisome form of borrowing is a loan that allows homeowners to borrow more than 100% of their equity. Interest rates and fees on these loans are typically high, and the borrowing taps future appreciation as well as current equity.

The many risks inherent in home equity borrowing have led some planners to discourage clients from taking out any kind of home equity loan except as a last resort to handle a severe financial crunch.

"I treat the home equity as a sacred cow," said Joel Framson, a certified financial planner in Los Angeles. "It represents the post-retirement security blanket for clients."

For example, people who have substantial home equity in retirement can borrow against it to pay for medical care or other major emergencies, Framson said. A paid-off mortgage also reduces living costs in retirement.

No one knows if today's workers will rein in their spending before they reach retirement age. The trend so far points the other way. A Brookings Institution study found that the average 60-year-old in the early 1960s spent 71% of what the average 30-year-old spent. That pattern has since reversed, with the typical 60-year-old spending 18% more than the younger counterpart.

One pattern that is unlikely to change for future retirees is that the cost of living in other retirement-magnet states will remain lower than California's. How much of a differential will persist, however, is unclear.

The cost of living in Las Vegas, for example, is currently about 25% less than that in Los Angeles. However, a population boom in Nevada's largest city is increasing home prices and living costs somewhat.

Retirees can still find bargains in more rural areas such as Klamath Falls, Ore., or Walla Walla, Wash., where it can cost two-thirds or less than what you'd pay to live in Southern California.

But that still leaves the question of how many retirees will want to uproot. Family ties, friendships and habit bind most elderly to their communities.

"There's no place I'd rather be," declares Ted Doty, 79, a retired meteorologist who with his wife, Marilyn, settled in Torrance 30 years ago. "I don't want to go to a remote area or some resort with resort-type activities" for the elderly, he said.

The couple chose Torrance for its good schools, ocean breezes and many activities, Ted Doty said. In retirement, the Dotys continue to enjoy these amenities by volunteering at the library, singing in a local chorale, organizing social groups for golf and conversation and taking adult education courses at local schools.

"It's been a good place to retire, as it turns out," Doty said.