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March 30, 2023
Home equity loans can be useful financial tools in retirement. However, these loans can be more difficult to secure after you have stopped working.
Let’s explore the different kinds of home equity loans, how you might want to use them for retirement, and why you should secure the loan while you still have work income.
A home equity loan, also known as a second mortgage, is a type of loan that allows homeowners to borrow money using the equity in their homes as collateral. Equity is the difference between the current market value of your home and the outstanding balance on your mortgage.
There are two main types of home equity loans.
There are pros and cons to each kind of loan.
The main benefit of a home equity loan is the fixed interest rate, particularly if interest rates are relatively low when you secure the loan.
The advantage of a HELOC is that you have access to money IF you need it, but you are not paying interest on those funds unless you actually withdraw money. Even then, you can limit your withdrawal to just what you need and not the full amount that is available in the line of credit.
Getting a loan before you retire, a milestone that many people believe should be debt free, may seem controversial. However, depending on your financial circumstances, a home equity loan may be smart financial move.
Here are some of the reasons you might want to consider getting a home equity loan before retirement:
Back up cash at the ready: The main reason that people consider securing a home equity loan prior to retirement is flexibility. Home equity loans provide a flexible source of funds that you can draw on as needed, which can be useful for managing unexpected expenses or financing home improvements.
Enables strategic financing: A home equity loan is a source of funds that can be strategically used to your advantage.
Pay off higher interest debt: Home equity loans typically have lower interest rates than other types of loans, such as credit cards or personal loans. If you are considering retirement, but are carrying debt at a high interest rate, a home equity loan could enable you to pay off those loans and carry the debt at a more tolerable interest rate.
Tax benefits: The interest on home equity loans may be tax-deductible, which can help lower your tax bill. Depending on your circumstances, taxes can be a significant concern in retirement.
Easier to qualify for a loan before you retire: There are a variety of factors that go into determining eligibility for a loan.
However, your income and the source of that income seem to be a primary factors and many retirees report having trouble qualifying even with a pension and Social Security as reliable income sources. (Securing a loan based on income from withdrawals can be trickier.)
So, securing the loan when you have income from work may make it easier to qualify.
Other loan determinants include:
While having an additional bucket of money in the form of a home equity loan may provide flexibility and other advantages, there are some real risks to having this debt when you retire.
The disadvantages of a home equity loan in retirement include:
Risk of foreclosure: If you fail to repay your home equity loan, your lender may foreclose on your home, which could lead to financial instability and the loss of your primary residence.
Reduced equity: Taking out a home equity loan reduces the equity you have in your home, which could impact your ability to sell your home for a profit in the future.
Interest rates can change: If you have a variable interest rate, it could make future payments untenable.
Fewer options later in life: If you secure a home equity loan and then spend the proceeds of the loan, you will have fewer options for flexible funding later in your life.
Many people strive to retain their home equity as a back up plan to help fund a long life or long term care. Explore more about using home equity in retirement.
Depending on the type of loan you secure, modeling a home equity loan in the NewRetirement Planner is possible.
For a home equity loan, you can simply add the loan balance to your mortgage.
Modeling a HELOC is a bit trickier and not as useful since most people use the HELOC as a flexible source of funds for when things don’t go according to plan.
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