Myth: Your house can finance your retirement

Wow! Both my dentist and David Lereah, the former chief economist at the National Association of Realtors, are going to be disappointed that Money Magazine now thinks that your house can't finance your retirement.

When my last crown was installed earlier this year and in this memorable quote from Mr. Lereah documented here at the end of last year, it seems clear that ever-increasing real estate "wealth" has been a key ingredient in many people's retirement planning.

In this Chicago Tribune story from last week, when asked to comment on a study by Moody's economy.com that house prices in some areas are set to "crash", Mr. Lereah remarked, "I don't think I would use the word 'crash'. When you use a word like that, it's almost a self-fulfilling prophecy in the housing market. These are people's homes. Their retirement is depending on it."

Here's Money Magazine's Myth #13 about retirement from their recent Retire Rich issue (I'm usually about a month behind in reading this personal finance mag, so if you've already seen this, sorry).

Treating your house as the ultimate retirement insurance is an easy trap to fall into. Even with the housing market in the doldrums, the five-year real estate bull market has likely left you feeling house-rich. According to a 2004 study by the National Economic Bureau, upper-income boomers ages 51 to 56 have a third of their net worth invested in their principal residence.

As recently as May, a survey of affluent boomers by financial adviser Bell Investments Advisors found that nearly 70% were relying on their homes as a retirement asset. Question is, will the strategy work? The answer is, not that well.

Why? Because it's hard to eat out on your home equity. You have to live somewhere. To turn your equity into cash, you can sell and then rent, move to a cheaper area or downsize. Most retirees prefer to stay put. Yes, you can do what a small but growing number of retirees are doing: Get a reverse mortgage, which is a loan against the value of your house that you don't have to pay back. (When you die or move out, the loan is paid off by the sale of the house, which means you may not be able to pass the home on to your children.)

But these loans give you much less than the value of your house. For homeowners ages 62 to 69, lenders will typically let you borrow just 49% of your home equity, says Wharton finance professor Nicholas Souleles.

The best way to look at your house is as a place to live, not a retirement account. So in the years leading up to retirement, don't overinvest in it with the idea that you can get that money out later. Keep your mortgage and other housing expenses to no more than 28% of your income, and don't prepay your mortgage instead of saving for retirement.

A house is "just a place to live"? That's a very "last-century" way to look at things.

I hope my dentist doesn't still read this blog - that crown has been starting to bother me a little bit and I may have to go back and see him.