How to Use a HELOC Strategically in Retirement
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If you've worked hard to pay off your house, taking on mortgage debt in retirement may sound as appealing as getting chained to a 9-to-5 desk job.
But used wisely, a home equity line of credit, which lets you borrow money against your home, can be a powerful tool to preserve the longevity of your financial portfolio.
Here's what you need to know.
How to use a HELOC in retirement
With a home equity line of credit, or HELOC, you can draw the amount of money you need, up to the credit limit, when you need it. Typically, you have 10 years to draw money and pay interest only on the amount you draw. Then you have another 20 years to pay back the balance, plus interest.
A HELOC is not a way to support an otherwise unaffordable lifestyle. Instead, it's an alternative to manage your cash. Here are a couple of smart uses.
Fund big purchases or projects
Using a HELOC lets you spread the cost over several years, so you don't have to withdraw a huge sum all at once from an investment portfolio, says Anthony Watson, a certified financial planner and founder of Thrive Retirement Specialists in Dearborn, Michigan. Taking a big chunk from retirement accounts can have tax implications — it could even bump you into another tax bracket — and you lose potential investment gains on the money you draw.
HELOCs usually have lower interest rates than personal loans and credit cards. In addition, the interest may be tax-deductible when used for home improvements, said Jon Giles, head of consumer direct lending at TD Bank, by email.
Before drawing from a HELOC, set a time frame for repayment that meets your goals, not just the lender's requirements.
Ride out a bumpy investment market
Financial planners generally advise keeping at least one to three years of living expenses in liquid assets — such as savings, checking or money market accounts — when you're retired. That way, you can rely on cash reserves when the market is down and avoid selling investments.
The drawback is what financial planners call "cash drag, the return essentially that you don't get from investing the cash," Watson says.
A HELOC can let you invest some of that cash while preserving your cover during a down market. Here's how it works: You'd draw from cash savings first for living expenses, and then, if needed, you could draw from the home equity line of credit while investment markets recover. Then, once it's a better time to sell investments, you'd pay down the HELOC, replenish savings and continue drawing from your investment portfolio, Watson says.
"Having a home equity line of credit in place for a market downturn, so you don't have to sell assets at an inopportune time, can be very strategic," says Marguerita Cheng, a certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland.
"If you're going to do this, make sure that you do so as part of a coordinated financial plan," Cheng says.
A financial planner can help you get the details right.
Qualifying for a HELOC in retirement
The average time from application to final approval for a HELOC is about 50 days and varies depending on the complexity of the application, Giles said.
To decide whether you qualify for a HELOC, lenders consider:
How much home equity you have.
Your credit rating.
Your debt-to-income ratio and ability to repay.
When someone is still working, the lender will verify income through pay stubs, W-2 statements or tax returns.
"For a retiree, income will still need to be verified and may include pension income, Social Security and/or income from retirement accounts," Giles said.
When a HELOC is a bad idea
A HELOC isn't a good idea for every situation. Generally, a HELOC doesn't make sense if you:
Plan to move in a few years. Lenders often charge a fee if the HELOC is closed within a certain period after opening it; a typical time frame is three years. When the home sale closes, you'll need to pay off the credit line.
Think you or your spouse may be tempted to overspend with a HELOC. In that case, the HELOC may not be worth the risk of draining the valuable equity you worked hard to build or, worse, facing foreclosure for failure to repay the HELOC.
Need income. A HELOC isn't designed to provide an income stream. However, a reverse mortgage may be an option if you're looking for a way to tap home equity for in-home care or other living expenses in retirement.
HELOC tips for retirees
Here are some tips for getting and using a HELOC.
Shop around. Cheng recommends getting quotes from at least three lenders, such as your bank, a credit union and an online lender.
Understand the costs. HELOCs typically have variable interest rates, but some offer the ability to convert to a fixed rate. When comparing lenders, understand the rates and how they may change, and ask about closing costs and whether there are any annual fees.
Beware: Banks can freeze credit lines. For example, many banks froze home equity lines of credit during the Great Recession and the housing crisis in 2008. "It hasn't happened recently, but that's something to be mindful of," Cheng says.
Be disciplined. Plan how you'll use the HELOC and repay any money you draw, then stick to it. "You don't want to say, 'I've got this line of credit, I can just go spend that now.' That's not the point," Watson says. "It's a risk-management tool and a cash-management tool. It's not an ATM."
