Many people strive to pay off all their debt before retirement. While this is a great goal, there are some types of borrowing that can make sense even once you are retired. A home equity line of credit—often referred to as a HELOC—is one type of debt you may want to consider using, even after retirement.
Here are five ways a home equity loan can be used to manage your cash flow and account withdrawals.
Key Takeaways
- There are several advantages to using a home equity line of credit when you're retired.
- You can use a HELOC for home repairs, auto purchases, or as a source of cash if the markets turn down and you lose some investment value.
- You can use a HELOC in retirement to fund a new home purchase when downsizing or use it to help the kids financially.
Auto Purchases
When planning for retirement, many people put together a basic budget and forget about expenses like buying cars or other things that may only occur every five or 10 years. If most of your money is held inside retirement accounts like IRAs and 401(k)s, then each time you make a withdrawal, that amount will be included as taxable income on your tax return that calendar year.
If you take a large withdrawal one year to fund a big expense, it may push you into the next higher tax bracket. For example, if your normal withdrawals were taxed at 15%, you could be taxed at 25% if you take more out. In these situations, it may be smart to use a HELOC to fund a large purchase, so you can pay it off gradually without taking a big taxable withdrawal all in one year.
Home Repairs
Just as with auto purchases, many people forget about the cost of home repairs when putting together their retirement budget. This is one of the items we refer to as a retirement budget killer. If you spend 20 to 30 years in retirement, your home will likely need some work done during this time.
A HELOC can provide an alternative to selling investments or taking large retirement account withdrawals. By borrowing the funds, you can gradually repay the money rather than disrupting your portfolio.
Alternative Source of Cash in Down Market
Managing money for retirement is quite different than managing money while you are in the accumulation years. Once you are taking regular withdrawals, a down market can have a more severe impact on you. In technical terms, this is referred to as “sequence risk.”
If you can either avoid or lower withdrawals in down years, you can increase the expected life of your portfolio and your potential lifetime income stream. A home equity line of credit can be used for this purpose—an alternative source of cash in down years, then you gradually repay it as your portfolio recovers.
Helping the Kids
Have an adult child who is moving, going through a period of unemployment, or otherwise needs assistance? Or maybe they need funds to start a business or buy a home. Many parents lend their adult children money, and the children repay their parents when they are able.
Whatever the reason, if you will incur tax consequences by selling investments, you might consider borrowing instead. If you have established a HELOC, it can be there waiting for you to use in these circ*mstances.
Funding a New Home Purchase
Many people retire, and within five to 10 years they decide to move. Whether it's being closer to grandkids, searching for a new climate, or something else, sometimes it just happens—even if it wasn't planned. In most of these cases, a new home is purchased before the old home is sold.
By borrowing against your home equity, you can often fund the down payment on the new home. Once again, this may be a better solution than liquidating investments, as selling investments will entail trading costs and tax consequences.
The Bottom Line
Applying for a home equity line of credit in retirement can make a lot of sense. Of course, you must have equity in your home. As long as you do, it doesn’t matter if your home is paid off or if you still have the first mortgage.
The key thing to remember is that you need to build your new loan payments into your retirement budget. Unless you’re moving soon, you’ll want to plan on repaying what you borrowed so you can use the line of credit again down the road if you need to.
FAQs
While accessing money from a home equity line of credit is not income, drawing from a HELOC is one of the retirement strategies that could help finance unexpected expenses, like medical bills or substantial home repairs, without drawing directly from your retirement savings nest egg to pay for the expense.
How to use your home equity for retirement? ›
Recommended options for how to use home equity in retirement often include things like:
- Paying for healthcare expenses.
- Remodeling your home to age in place.
- Moving into a new home or long-term care facility.
- Paying off higher-interest debt such as credit cards.
- Supplementing your monthly income for living expenses.
It is generally accepted that for short-term loans, HELOCs are more cost effective than reverse mortgages, especially for loans of between 3-5 years. Seniors with good credit should qualify for a HELOC interest rate that is near the prime rate.
How to strategically use HELOC? ›
How Do You Strategically Use A (HELOC)?
- Smart Debt Management with HELOCs. Reducing Mortgage Debt. Consolidating Debts.
- Investing in Your Home and Beyond. Boosting Property Value. Diversifying Your Portfolio.
One of the most common and practical uses of a HELOC is for home improvements. By investing in renovations and upgrades that increase your home's value, you are effectively building wealth in the long run. A higher home value means greater equity, which can be realized when you eventually sell your home.
How to smartly use a HELOC? ›
Consolidating and paying off high-interest debt
Either way, a HELOC can get you out from under, as it generally offers a lower interest rate than unsecured loans, and certainly a lower rate than your credit card's APR. So it's a good choice for paying off credit cards or consolidating other types of high-interest debt.
How to turn home equity into income? ›
You can convert equity to cash through either a sale or a loan, which can then be used in multiple ways, including investments in stocks, bonds, real estate, and business opportunities. By converting equity to opportunity, you can grow your total assets and sources of income.
Will a home equity loan affect my social security benefits? ›
Therefore, taking out a home equity loan, which is a form of debt rather than income, generally would not affect your Social Security disability benefits. The funds you receive from a home equity loan are not considered income because you are obligated to pay them back.
How can I use my home equity without selling it? ›
Home equity loans, home equity lines of credit (HELOCs), and cash-out refinancing are the main ways to unlock home equity. Tapping your equity allows you to access needed funds without having to sell your home or take out a higher-interest personal loan.
What should you not use a home equity loan for? ›
Home equity loans ideally should be used to finance home improvements or consolidate debt at a lower interest rate — but not to cover holiday, vacation or everyday expenses, buy a car, or invest.
Yes, you can get a HELOC and not use the funds. However, getting a HELOC and not use it will cost you time and money in lender fees and account fees that we'll discuss in detail below. If you do not intend to use the HELOC right away, you'll be paying money for a loan you don't really need.
Can you walk away from a home equity line of credit? ›
A HELOC is borrowing, which must be repaid with interest and using your home equity as collateral for the loan, in the event of a default, is not an obligation you can just walk away from,” says Greg McBride, chief financial analyst at Bankrate.
Is a HELOC a trap? ›
But it also carries risks. With a HELOC, your home is used as collateral, and you could lose it to foreclosure if you fail to make your payments. HELOCs also typically have variable interest rates that can cause your monthly payments to change over time.
Can I use my HELOC for anything I want? ›
And you can use the money any way you'd like! Some of the best ways to use a HELOC include making home improvements, paying for college, consolidating high-interest debt, paying for higher education tuition, starting a business, and much more.
How do I use my HELOC wisely? ›
Top 6 ways to use a home equity line of credit wisely
- Make smart home improvements. ...
- Consolidate high-interest debt. ...
- Supplement your emergency fund. ...
- Make college more affordable. ...
- Care for an elderly parent. ...
- Move into a new home on your own schedule.
According to Suze Orman, a HELOC might be a useful backup option in an emergency. However, this strategy only works if you don't use the credit for other expenses, such as home improvements or college funds. In an episode of her podcast, Orman advised a listener to keep their HELOC open as an emergency fund.
Does a HELOC count as income on taxes? ›
HELOC interest can be tax deductible if it meets the IRS guidelines. The rules are the same for a home equity loan and a HELOC. This means the loans must not exceed the stated loan limits, and you must prove you used the funds to buy, build or improve a home.
Does a HELOC count against your debt to income? ›
Your debt-to-income (DTI) ratio is the percentage of your monthly income that is committed to paying off debt. That includes debts such as credit cards, auto loans, student loans, mortgages, home equity loans, and home equity lines of credit (HELOCs).
Can you get a home equity line of credit on Social Security? ›
To improve your chances of getting approved any income you receive should be included in your HELOC application. The following forms of income are appropriate to include: Social security payments.
