Owning a home comes with significant benefits. One of the greatest advantages is that you accumulate equity as you repay your mortgage. The more you pay off, the more equity you have. If you’re looking to perform home improvements, consolidate debts, or make a large purchase, you can use that equity to finance your needs.
Many people strive to have most, if not all of their debts paid off by the time they retire—homeowners included. In some cases, however, retired homeowners may need to borrow money, and they may choose to do so by using a home equity loan.
While it might seem counterintuitive at first glance to take out a loan when you’re not working full-time anymore, borrowing against your home makes sense in some situations. Here’s what you need to know about getting a home equity loan after retirement.
Why Get a Home Equity Loan After Retirement?
Just because you’re retired doesn’t mean you don’t have goals or needs that cost money. There are a few reasons you might consider taking out a home equity loan:
Even in retirement, your house may need repairs. You may also want to upgrade certain areas of your home, such as your kitchen or bathroom. A home equity loan provides you with an alternative to tapping into your investments. Additionally, interest paid on the funds used for improvements and upgrades is tax-deductible.
A New Car
There may come a time in retirement when you need to buy a new vehicle. You could withdraw the funds from your retirement account, but the money you pull becomes taxable income. Withdrawing too much could push you into the next tax bracket, increasing what you owe come tax time. With a home equity release, you can leave your IRA or 401(k) alone.
A New Home
If you’re looking to move in retirement and thinking “can I use home equity loan to buy another house?” Using your equity through a sale-leaseback, you can buy a new home before you sell your current one.
Helping Your Children
Even when your children are adults, you may want to help them if they become unemployed, want to buy a home, or have a medical emergency. A home equity loan enables you to loan your adult children the money they need without the tax consequences of reaching into your investments.
Pros and Cons of a Home Equity Loan
As with any loan option, there are benefits and drawbacks to taking out a home equity loan in retirement. Weighing the pros and cons will help you decide if this is the right solution for you.
- Interest rates tend to be lower than with personal loans or credit cards.
- Lower rates mean more manageable monthly payments.
- You don’t have to tap into your retirement or investment accounts.
- You can use the funds for anything.
- Interest paid on money used for home improvements is tax-deductible.
- A home equity loan is a second mortgage, which means you have two home loan payments.
- A second mortgage has a slightly higher interest rate than a first mortgage.
- You have to use your house as collateral, which means you risk foreclosure if you can’t make your payments.
- You may not qualify if you have too much debt or poor credit.
Getting a Home Equity Loan After Retirement
To get a home equity loan, you need to fill out an application. When you apply, you will need to prove your ability to repay what you borrow. As a retiree, documents to provide may include such items as:
- Copies of your award letters (such as those for your Social Security)
- Payment stubs
- Recent statements for savings and investment accounts
- 1099 forms for the past two years
When getting a home equity loan, you should keep in mind that you need to leave at least 15% to 20% equity in your home. You can’t borrow the entire value. The lender will look at your debt-to-income ratio and credit history to determine your eligibility as well as your rate. If approved, you will need to close on the loan and then make your monthly payments based on your specific terms.
Home Equity Loan Alternatives
As a retiree and homeowner, you have a few other options for tapping into your home’s equity. Here are a few alternatives to consider:
If you still have a mortgage, you might consider a cash-out refinance. With this option, you replace your current mortgage with a new one. The funds pay off your existing mortgage, and you receive the rest—minus the amount you need to leave in equity—in the form of a check. One downside to a cash-out refi is that you extend the amount of time you’re paying off your home.
Reverse Mortgage Loan
A reverse mortgage is a type of loan available to homeowners 62 and older. With this option, the mortgage lender pays you. Typically, you don’t have to repay the loan while you live in your home, but the amount you owe increases over time. You or your heirs repay the loan when you no longer live there, generally by selling the home.
Sell Your Home and Downsize
If you’re considering a move, you don’t necessarily have to take out a home equity loan. Another option is to sell your current home and purchase a smaller one.
What if you’re considering selling, but you don’t necessarily want to leave the home you love? With a sale-leaseback, you don’t have to. Instead, you sell your house to a company—but you don’t have to pack and move. You just have to pay a monthly agreed-upon lease.
Even after retirement, your house can work to your advantage. With a home equity loan, you can get the money you need to improve upon your home, consolidate any remaining debts you might have, or finance a larger purchase. No matter what your needs, make sure to do your homework and talk to a financial advisor to ensure it’s the right financial move for you.