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Financing

5 Ways to Tap Your Home Equity to Live Well in Retirement

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There are plenty of reasons why many people today aren't financially prepared for retirement. We're living longer, so we have to stretch our savings further. And the pensions that helped previous generations have largely vanished.

But that doesn't mean it's time to panic quite yet.

Truth told, many on the cusp of retirement do have one source of cash that could help them close the gap between what they have for retirement and what they'll need to live well: their home.

In fact, the majority of senior Americans have more money in home equity than they do in their retirement portfolios, according to an analysis last year by the Center for Retirement Research at Boston College. So how much cash are you sitting on, anyway? To figure out your home equity, subtract the amount you owe on your mortgage from the current market value of your property. Next, to see whether you'll need that money in retirement, plug your other info (excluding the value of your home equity) into a retirement calculator, then see whether you'll be able to comfortably live without it.

"A lot of people think of their home equity as their Plan B for retirement, but for a lot of people it really has to be their Plan A," says Jenna Rogers, a client adviser with Mission Wealth.

If it looks like you're going to have to tap your equity, you'll want to make a plan for the best way to do so. Here are five options, and the benefits and drawbacks of each.

Option 1: Sell and move

This is probably the first thing retirees think of doing with their home, and for good reason: Many retirees feel liberated after shedding their excess stuff to move to smaller digs.

Pros: By selling and moving to a less expensive house or region, you'll not only bolster your portfolio with the proceeds, you'll also lower your monthly expenses. And if you move to a condo or apartment, you won't have to deal with external home maintenance issues anymore.

Cons: Moving can be stressful and far from ideal. Nearly two-thirds of baby boomers don't plan to move in retirement, according to a 2014 survey by the Demand Institute.

Option 2: Open a HELOC

If you have enough cash to cover your day-to-day needs but no cushion for unexpected expenses such as medical bills, a home equity line of credit can serve as an emergency fund.

"For somebody who doesn't have a cash safety net, a HELOC is a way to get peace of mind," says Andrew Rafal, president and founder of BaynTree Wealth Advisors.

Pros: You get to stay in your home. You'll have to pay only the interest on the amount you use during the "draw period," typically 10 years. Interest rates are so low now that those payments will be pretty minimal.

Cons: When the draw period ends, you'll need to pay back the principal as well -- and rates will likely be higher than they are now. So if you use a HELOC, focus on paying off the debt before the adjustment hits.

You typically need to prove your income to get approved for a HELOC, so if you've already retired you may have trouble securing one. A lender can also freeze a HELOC if it's concerned your home's value has gone down or you'll be unable to make the payments.

Option 3: Use a reverse mortgage

A reverse mortgage allows you to tap your home's equity but is different from a HELOC in that you don't have to pay it back until you move or pass away.

Pros: Unlike a HELOC, which is good for short-term borrowing, a reverse mortgage gives you cash for the long haul in the form of monthly checks, says Damon Gonzalez, founder of Domestique Capital.

Cons: The fees associated with a reverse mortgage are high, although they're typically rolled into the loan so you won't have to pay them upfront. Since a reverse mortgage can eat through the equity in your home, there may be little or none left to pass on to your heirs, or if you eventually decide to move.

Option 4: Become a landlord

It may not be a huge investment to turn part of your home into an apartment with its own kitchen, bathroom, and entrance. Or, you can rent out your entire home for all or part of the year, rent a smaller unit yourself, and pocket the difference.

Pros: You can cover or offset your housing costs with rental income -- and postpone selling your home for longer than you might otherwise be able to.

Cons: You'll have to deal with all the headaches that come with having tenants. Be ready for 3 a.m. phone calls, and have enough cash in reserve that the apartment or home can be vacant between renters.

Option 5: Do a sale/leaseback to your kids

If passing the family home to your children is important to you, you may be able to sell it to them now and then pay rent so that you can continue living there.

Pros: You get to stay in your home and ensure that it remains in the family.

Cons: Your children have to agree to the deal and have the cash to make it work. You're also setting yourself up for potential conflicts with your children if you ultimately have trouble paying the rent or need them to take care of repairs or other issues.