Saving for retirement involves a lot of planning and hard work. Often, people strive to pay off all of their debt before they retire, so the thought of taking on new debt in retirement can be difficult for many people to consider. At the same time, taking on new debt after retirement can prove a smart decision in some circumstances. For example, using a home equity line of credit, which allows for borrowing against the value of a home, can support the longevity of a financial portfolio without putting it at undue risk.
The amount of money available through a home equity line of credit is set at the value of the property and people can borrow any amount up to that limit at any time for the life of the account. These accounts typically remain open for a period of 10 years. During that time, borrowers pay only interest on the amount withdrawn. After, borrowers usually have 20 years to pay back the balance and any interest due.
When a Home Equity Line of Credit Can Prove Beneficial
In retirement, a home equity line of credit often becomes most beneficial when making purchases for large projects. If you were to take money out of a retirement account for such a project, you would typically do so in one large chunk of money even if you only plan to spend it in small increments over time. Importantly, this would be a taxable event unless the withdrawal was from a ROTH IRA, so the cost of the project would be higher by the amount of the taxes due! Also, this sort of withdrawal can end up bumping you into the next tax bracket if you are not diligent about the amount you are taking out, and it can also limit the future returns from that retirement account. A home equity line of credit does not have the same implications since you can take small amounts out across the lifespan of the project, which means minimizing interest without worrying about tax implications. In fact, the interest may even be tax deductible if you are using the money for home improvements.
Another way that home equity lines of credit can prove helpful is as a support during particularly rough investment market environments. Financial planners usually recommend that retirees keep one to three years’ worth of living expenses in liquid assets, such as money market accounts. That way, retirees are not obligated to sell investments when the market is down and thereby lock into those losses. Instead, liquid assets can cover expenses until the market improves. A home equity line of credit can play a similar role in a retirement strategy. The line can be used to cover expenses and then the investment account can pay down the debt once the markets are performing better. This strategy helps avoid one of the key problems with the cash-based approach. Namely, any money held in a liquid account is not invested and thus not meeting its full potential.
The Pitfalls of a Home Equity Line of Credit in Retirement
Of course, a home equity line of credit is not always the best choice and using it in the wrong situation can end up creating new problems. Because this strategy creates debt at a time when income is limited, it is important to be exceedingly diligent. One situation in which this line of credit should not be used is if you plan to move in the coming few years. Many lenders will actually charge a fee for closing the line of credit within a certain period after opening it. This period is often set at three years. Unfortunately, the sale of the underlying asset will force the closure of the line of credit and make the balance become due. Thus, this strategy is not ideal for anyone thinking about moving in the next several years.
The other thing to keep in mind about a home equity line is that it is not a revenue stream. When people start to treat it as a source of income, they can quickly dig themselves into a hole much larger hole than they intended. If you need income, you can consider a reverse mortgage, which is a way of tapping some of the equity in your home, and which does not require any payments from you. Along those same lines, it is important to budget exactly within the bounds of the line of credit. If you overspend, you may put your home on the line and create a very stressful situation for yourself. When someone is not able to repay the home equity line in full, the home will go through the foreclosure process to recoup the money.
How Retirees Can Find the Best Home Equity Line of Credit
Not all home equity lines of credit are created equal so it is important to shop around, especially in retirement. Getting quotes from at least three different lenders can help people get a sense of the range of possibility in terms of both rates and rules. When comparing these offers, it is important to look specifically at the costs involved. These lines of credit most often have a variable interest rate, but some will come with the ability to convert to a fixed rate, which can be more desirable for many people. Sometimes, there are fees attached to this conversion. Beyond that, fees often get assessed at closing and some lenders may have an annual fee. Always look at the full fee schedule as these costs can vary radically between different lenders.