Personal Finance

Mortgage-Free? What to Do With That Equity

Jane Birnbaum|The New York Times

This is a story about the other homeowners. Not the ones who are having trouble making their mortgage payments and getting all the attention lately. No, this is about the homeowners who do not owe any money on their primary residences because they have paid off their loans.

They are the ones, generally, who did not get caught up in the home buying frenzy earlier in this decade. And they are the ones the banks would love to serve.

According to the Census Bureau, of the some 75 million people who reported owning their own homes in 2006, approximately 32 percent said they had no mortgage. The median value of a mortgage-free residence in 2006 was $140,400, the Census Bureau found.

Mortgage-free homeowners tend to be older, according to Richard Riley, a professor of accounting at West Virginia University. Using the latest available census data, from 2000, Mr. Riley and colleagues found that 74.9 percent of owners 70 and older had no mortgage on a primary dwelling, compared with 55.4 percent of those in their 60s and 31.2 percent of those in their 50s.

The question for these consumers is what to do with a houseful of equity. The answer depends on whether they have enough cash flow to meet their needs.

Susan Wachter, a professor of real estate at the University of Pennsylvania, said that “those who need to sell or borrow now are exposed to the turmoil of the market.” But, she added, “Those who don’t need money are in a good position — interest rates are low and their ability to borrow has never been better.”

Because a home is more than an investment, older consumers, especially, may require professional help to crunch the numbers needed to make decisions, said Dean Baker, co-director of the Center for Economic Policy Research in Washington.

Consumers who lack enough cash flow to stay in their homes without borrowing have tough choices. For those 62 and older, an option is a reverse mortgage. These loans generate monthly payments to the borrower, in return for the lender putting a lien against the property that is paid off after the borrower leaves it or dies.

“But even the best reverse mortgages are expensive, the amount of equity that can be paid out is limited, and the risk of interest rate fluctuations reducing what heirs can inherit is sometimes greater than disclosed,” said Conrad Kuiken Jr., a Realtor and mortgage broker in Carlsbad, Calif.

Another option is taking a home equity loan or home equity line of credit — a Heloc, which is used like a credit card — to pay expenses. But here, too, borrowing is limited, said Percy Bolton, a certified financial planner in Pasadena, Calif., because lenders want documentation of income to repay loans.

Many homeowners who may need to tap their equity soon or down the road should sell and downsize now, according to Mr. Bolton. “Take the profit and divide it up into a number of areas,” he advised. “Deposit some in an annuity but don’t lock it up, and some in bonds, especially municipals if possible and maybe some corporate blue-chip AAA-rated.”

One other piece of advice, he said, “Stay away from the stock market until we have clarity about who will be elected president, and then dollar-cost average in over the next 36 months.”

Consumers with a reliable income and frugal ways, plus a mortgage-free home, have the most flexibility.

In Los Angeles, Florabel Kinsler, 79, a clinical social worker who practices part time, has calculated that she can comfortably manage aging in her house. Her bills include repairing the 60-year-old house, where she has lived for 36 years. It stands on land valued at over $2 million, she said.

Ms. Kinsler has adequate income thanks to a pension from her deceased husband, who was an aerospace engineer; long-term care policies; and a lifetime of careful investment and spending. “We never took a loan against the house,” she recalled. “Then, when we were older and wanting to avoid risk, we realized that if we continued to live moderately, we wouldn’t have to borrow.”

Linda and Paul Spiegler, a travel agent and a solo-practice physician, also said they watched their spending. They were able to pay off their house in Washington as well as work less as they moved into their 60s.

Five years ago, Ms. Spiegler won a property tax reduction when she persuaded a city assessor that her home was not in good condition. When Dr. Spiegler turned 65 the next year, the couple took advantage of property tax breaks for older citizens with household incomes under $100,000.

Bernadette and Conrad Kuiken — both 75 and the parents of Mr. Kuiken Jr., the California mortgage broker — live in a mortgage-free home on Long Beach Island in New Jersey that, they said, is now valued at more than $2 million. Because they each come from families that lost homes in the 1930s, they used to keep a year’s worth of mortgage payments in the bank. “We did it through very conservative living and my husband’s good fortune as a union electrician,” Ms. Kuiken explained.

Today, the Kuikens’ property tax on their primary residence plus a rental house nearby totals about $20,000 annually. “It’s always at the back of my mind,” Ms. Kuiken said. “The average person would be in pain having to pay that. We have a pension, Social Security, a good annuity fund and interest- and-depreciation tax deductions on our rental.”

Three years ago, the Kuikens said they refinanced the rental, which had also been paid off, after their son persuaded them to increase their cash flow and liquidity. They invested about 30 percent of its equity in New Jersey municipal bonds.

Such diversification is wise, said Gibran Nicholas, president of the Certified Mortgage Planning Specialist Institute in Ann Arbor, Mich. “If the housing market goes down and you need access to that wealth, it’s available to you,” he said.

Banks may be eager to lend to such consumers but homeowners should be cautious, said Allen Fishbein, director of credit and housing policy for the Consumer Federation of America in Washington.

Josephine Damon, the maiden name of a homeowner in Long Beach, Calif., who did not want to be further identified, said she and her husband walked away before signing a $900,000 Heloc on their paid-for home valued at $1.2 million. Both longtime real estate investors in their 80s, the couple said they wanted a Heloc established in case an earthquake temporarily disrupted rental income from their apartment building.

The loan had been approved. But when the couple read the contract before signing, they learned that they would be waiving many federal and state consumer protections, including California’s anti-deficiency law. (Such state laws make it harder for lenders to pursue borrowers’ other assets if they default on home loans.)

“When we told a manager that we couldn’t accept that language, no one offered to amend it and we walked out,” Ms. Damon said. “For now, we have decided to manage without a Heloc.”

Bothering to read the small print is “a marvelous thing,” said Sandy Rae, a trusts and estate lawyer in Manhattan Beach, Calif. “Banks wouldn’t put language in contracts unless they intended to make use of it later if it benefited them,” he said, adding that consumers can negotiate and sometimes still get desired loans after striking out troubling terms.

About two years ago, Jim Thorbeck, a retired union maintenance mechanic in the Midwest, and his wife decided to borrow against their paid-for home, then valued at about $100,000. “We were able to pay off our home because I had never been laid off,” Mr. Thorbeck said.

To build a sunroom for their 11 grandchildren to play in and work space for Mr. Thorbeck to ply his trade as a fifth-generation safe repairman, the couple took a $50,000 10-year fixed-rate loan. But because he worried about his wife making the monthly payments if something happened to him, Mr. Thorbeck, now 65, said he also took out a $50,000 life insurance policy that expires when the loan is paid off.

Although homeowners without mortgages tend to be older, some are in the thick of working years. “Typically, when people sell a business, the first thing they do is pay off their mortgage, but that may not be a smart financial decision,” Mr. Nicholas of the mortgage planning institute said.

Joe Belew, president of the Consumer Bankers Association in Washington, suggested that consumers of every age who have paid off their mortgages save the same amount monthly. “Keep socking it away,” he said, “and you can borrow from yourself.”