Why You Should Consider Opening a HELOC Before Retirement

Should you tap into your home equity before you retire? Learn about the best uses for a home equity line of credit and when you should open one.

There may be a hidden retirement resource in your home. When you think of funding your retirement, you may not consider your home as a source of savings. Home values over the last several years have risen consistently in most areas, and that adds to the equity you are already building as you pay down your mortgage. Tapping your home equity via a HELOC might be a smart move as you prepare to retire.

What Is a Home Equity Loan vs. a HELOC?
Home equity is the difference between what your home is worth and what you owe on your mortgage (the principal). You can see from this definition that as the value of your home goes up and the principal balance on your mortgage diminishes, you are earning equity in two ways.

To make use of the equity in your home, you have two options. You can either borrow against it in a home equity loan, or you can open a home equity line of credit. The differences between a loan and a line of credit are important to understand in this context.

• Home Equity Loan
  A home equity loan is a simple financial product that allows you to take a lump sum of cash based on the amount of equity you have in your home. As soon as you get the loan, you will begin paying it back at a fixed interest rate over a certain period of time. If you want to borrow more money, you must apply for another loan.
• Home Equity Line of Credit (HELOC)
  A HELOC works similar to a credit card, with your credit limit based on the equity in your home. As you repay the outstanding balance, your available credit is replenished. You also have the flexibility to draw as much or as little as you need up to a preset limit during the draw period

A HELOC usually begins with a 10-year draw period, followed by a 20-year repayment period. The best way to manage a HELOC is to repay it during the draw period when required minimum monthly payments only include interest. Both home equity loans and HELOCs use your home as collateral. If you default on either one, you could lose your home.

Best Uses for a HELOC In Retirement
A home equity line of credit could be the most economical source of funds for large projects around the retirement years. Having it offers you the flexibility of a low interest rate and repaying over time. Here are some ways you may choose to use your HELOC:

• Renovation for the Future
  As you approach retirement, you may realize that your family home may not be suited to your physical needs as you age. With funds from your HELOC, you could add a first-floor master suite or walk-in shower stall, or convert an extra bedroom into a home gym. This could be a good time to update your kitchen or install air conditioning to help you enjoy a comfortable retirement when you might be spending more time at home.
• Early Retirement Distribution
  If you retire early, drawing your retirement benefits will present tax implications. You may want to use your HELOC to create an income for yourself until you are old enough to collect retirement benefits with the greatest tax advantage. Then, you can pay back your HELOC over time.
• Vehicle Purchase
  When you are retired and living on a fixed income, large expenses can present an unexpected challenge. If you need a new car and did not plan for it in your retirement budget, the finances can get a little tricky. Using your HELOC to purchase a new vehicle gives you the opportunity to pay it off over time at a lower interest rate and doesn’t require you to draw extra money out of your retirement account.
• Supplemental Income
  Most retirement accounts are affected by the market. If the stock market has a down year, your income may fall short of your expectations, resulting in a budget gap. You could use your HELOC to fill that gap without touching your investment principal or incurring tax consequences that can happen when selling investments. When the market recovers, you’ll be able to pay it back over time.
• Retirement Home
  You may decide a few years into your retirement that you’d like to move to be closer to the beach or the grandkids. Using your HELOC to fund the down payment on your new house or condo can help you get the best mortgage terms available. It will also be helpful if you need to make a purchase before your current home is sold.
• Help for Your Children
  Sure, your kids will likely be grown and off on their own by the time you retire, but that doesn’t mean you won’t want to help them when large expenses come up. You could use your HELOC to help them buy their first house, move across the country for a great job, or pay off college loans so they can get their own mortgage.

You may never need extra money for any of these events, but wouldn’t it be nice knowing you have access to that money if you do? Opening a HELOC before you retire could be an excellent way to provide a financial safety net in the early years as you adjust to the retirement lifestyle.

What to Avoid With a HELOC in Retirement
Banking on the equity in your home by opening a HELOC is a great idea, but it is not the best way to solve all financial problems. A HELOC affects your credit and your debt load just like a credit card does. Plus, repaying anything you use on your line of credit will add an extra bill to your monthly budget.

Think of your HELOC as a giant credit card with low interest, and always have a plan in place to pay it off before you spend. Using your HELOC as a source of ongoing additional retirement income is not advisable.

If you want to supplement your retirement income, use the money from your HELOC to invest in something that can generate the additional income you need long term. Use the money as a down payment on a rental property or seed money for a business.

You will need to pay all this money back eventually, so have a plan. Remember, the limit on your HELOC is based on the equity you own in your home. HELOC limits are typically capped at 85% of the home’s value. You should be able to pay off the HELOC with the proceeds from the sale of your home, but that could make a significant dent in the amount of money you get at closing to buy your next home.

Why Open a HELOC Before Retiring?
Although a HELOC is secured by your home, there are still requirements for opening one. Two of these requirements – low debt-to-income (DTI) ratio and sufficient income – are easiest to meet while you are still working. After you retire, your income may be diminished and may not meet the threshold for the amount you want to borrow. If your income decreases and your debt load remains the same, your DTI will rise.

Once you open your HELOC, you can draw on it for up to 10 years and take 20 years after that to pay it off. You could open it prior to retiring, and you don’t have to use it right away. It will be there if and when you need it throughout the early years of your retirement – just in case.

Learn More
A comfortable retirement requires careful decision-making and a lot of financial planning. To learn more about opening a HELOC before you retire, contact your financial institution.