Homeowners who are no longer in the workforce might wonder whether it's smart to use their home equity in retirement.
The answer is yes, no and maybe.
That's because what makes good sense for one retired homeowner might not make sense at all for another.
In theory, you can use your home equity for a long list of financial needs and wants.
- Making repairs or improvements to your home
- Paying for your daily costs of living
- Paying for medical care for yourself or a loved one
- Paying for long-term care for yourself or a loved one
- Beefing up your retirement savings and investments
- Paying off your credit card, auto loan, student loan or other debt
- Starting a new business
- Setting up an emergency savings account
Any or all of those uses might be smart, but you should think carefully before you decide because there are risks as well as rewards if you use your home equity in retirement.
What to Consider
Perhaps the most important factor is whether you'll be able to make the monthly payments on your home equity loan. If you can't make the payments, home equity financing might not be appropriate for you because the lender could foreclose and you could lose your home.
Another factor to consider is interest rates. If mortgage rates are low, home equity financing could be attractive. If you plan to invest the money you borrow, compare the interest rate you'll pay for your loan with your anticipated after-tax rate of return on your investments.
If you plan to pay off other debt with a home equity loan, think about whether you can avoid accumulating new debt in the future.
If you have a habit of using debt to spend more than you can afford, borrowing against your home equity might not be a good solution. A home equity loan can be cheaper than other types of debt, but that's only because your home serves as collateral.
5 Ways to Tap Equity
There are five ways to borrow against your home equity in retirement, each with pros and cons.
1. First mortgage. If you currently own your home without a first mortgage, you might be able to get a new first mortgage and take the proceeds in cash.
2. Cash-out refinance. If you already have a first mortgage, a cash-out refinance could let you pay off your existing loan and get a new one with cash back if you have enough equity.
3. Home equity loan. A home equity loan is a second mortgage that gives you cash without paying off your first mortgage. A home equity loan usually has a fixed rate and term.
4. Home equity line of credit (HELOC). A HELOC is a line of credit that allows you to borrow money when you need it and repay it when you can. After an initial period of a set number of years, you'll have to start making monthly payments to pay back what you borrowed.
5. Home equity conversion mortgage (HECM). Also known as a reverse mortgage, a HECM allows you to tap your home equity without making payments. This type of loan must be repaid after you die or move out of your home.
Which of these options would be best for you depends on how much equity you have, how much you want to borrow and when you want to repay your loan, among other factors.