5.2 Potential contribution of home equity
Ageing population and longer life expectancies have led to an extensive debate on mechanisms for funding retirement income. From the private perspective, discussion centres on the need for more aggressive saving rates before retirement, accepting a lower level of retirement consumption or extending the period of labour-force participation. As a significant part of wealth for many households is the principal residence, releasing equity from the home has featured increasingly in debates about retirement income options.[14]
Home equity can be released pre-retirement through equity withdrawal for more liquid forms of investment. After retirement, home equity can be freed up by `downsizing' or by reverse equity mortgages. In this paper, we do not enter into the specifics of the actual mechanisms. Rather, we explore the extent to which using some portion of home equity could augment retirement income and so decrease the level of required savings.
Section 5.1 assumes that the current equity in the owner-occupied house is retained for bequests. For this analysis we assume that mortgages on the principal residence will have been paid off by the time the household retires. Accordingly, at the time of retirement the household's home equity will be equal to their share in the gross value of the house.[15] Their wealth in the `other' category will be commensurately reduced by the outstanding value of the home mortgage. In fact, the vast majority of retirees own their home free and clear. As reported in Appendix Table 6, 59% of all property owners have a mortgage liability, compared with only 8% among those older than 64. The latter rate is even lower (7%) when property investors are excluded. The average mortgage debt is also considerably lower among the older people.
Table 9 shows the extent to which home equity withdrawal affects the required saving rate. The relative impact is similar across the distribution. If the house is to be retained and bequeathed, the median prescribed after-tax saving rate for couples aged 55-64 is 23%. This rate drops to 22% when 10% of home equity is withdrawn, and to 15% when half of housing wealth is to be released. At the 90th percentile, the prescribed saving rate falls from 49% to 47% and 43% respectively. By construction, lower prescribed saving rates mean higher replacement rates and higher retirement consumption. That is, by converting housing wealth into income in retirement, households are able to achieve better consumption smoothing over the life cycle and thus to enjoy higher consumption in retirement.
| Ages 45-54 | Ages 55-64 | |||||||
|---|---|---|---|---|---|---|---|---|
| Percentile | 25th | 50th | 75th | 90th | 25th | 50th | 75th | 90th |
| Non-partnered individuals | ||||||||
| Retain the house | 0 | 16 | 30 | 38 | 0 | 5 | 31 | 44 |
| Withdraw 10% of home equity | 0 | 15 | 29 | 36 | 0 | 2 | 29 | 43 |
| Withdraw 30% of home equity | 0 | 14 | 27 | 34 | 0 | 0 | 26 | 40 |
| Withdraw 50% of home equity | 0 | 12 | 26 | 32 | 0 | 0 | 23 | 38 |
| Couples | ||||||||
| Retain the house | 8 | 25 | 33 | 39 | 0 | 23 | 39 | 49 |
| Withdraw 10% of home equity | 7 | 24 | 32 | 38 | 0 | 22 | 37 | 47 |
| Withdraw 30% of home equity | 5 | 22 | 30 | 36 | 0 | 19 | 34 | 44 |
| Withdraw 50% of home equity | 3 | 21 | 29 | 35 | 0 | 15 | 31 | 43 |
Note: See Table 7, page 11.
The effect of home equity withdrawal appears modest; it is only noticeable when households halve the size of their home. However, there are significant transaction costs in releasing home equity which we have ignored. These costs would further reduce the potential role of home equity to alleviate the pressure on saving. While housing wealth may well represent a buffer for some households facing uncertain income and expenditures in retirement,[16] this analysis suggests that reverse equity mortgages or ‘downsizing' has a limited role in easing the need for saving.
