The collapse of the housing market has provided a painful lesson for those who were counting on their homes as a source of retirement income. Falling home prices illustrate the potential difficulties of relying on the sale of a home to pay for retirement.

Since 1987, U.S. housing prices have risen 4.1% annually. During that same period, the Consumer Price Index rose 3% annually. Thus, when you subtract inflation, home prices produced a real return of only 1.1%. Additionally, you need to factor in property taxes, maintenance, and insurance, which can all serve to erode the long-term growth of a home’s value.

Movin’ on Out

The prospect of cashing in your home’s equity to pay for retirement may be enticing when home prices are rising. However, when prices are falling, it’s much easier to see why this is an unreliable strategy.

First, home values are subject to cyclical trends, so there’s no guarantee that your home will be worth what you were planning on when you are ready to retire. There is also the possibility that, depending on market conditions, you may have trouble selling it.

Next, you’ll still need somewhere to live. If you buy a smaller place, you will need to pay transaction and relocation costs, which could consume money you thought would help pay for retirement.

Throw It in Reverse

One way for older homeowners to capitalize on the equity in their homes is a reverse mortgage. But despite their recent surge in popularity (the government insured 11,660 reverse mortgages in April 2009, the highest monthly total since the program began in 1990), reverse mortgages may not be an appropriate strategy for some people.

Homeowners aged 62 and older can use a reverse mortgage to borrow against the value of their homes, and there’s no need to pay back the loan as long as they continue to live there. The loan is paid off by the sale of the home after they move out or after both spouses pass away. The amount a homeowner might be able to receive from a reverse mortgage will depend on the loan’s interest rate, the owner’s age, and the home’s equity value. Reverse mortgage loan fees are typically high and can reach up to 10% of a home’s value over the life of the loan.

The collapse of the housing market has caused many people to take a second look at the way they view their homes.