Your Home Equity and Retirement: What You Need to Know

It might be an unpopular topic—but living on a fixed income has its limitations. Yes, the right retirement plan should cover your day-to-day expenses. But you may still find after retirement that you want or need additional funds due to lifestyle changes, home renovation plans, health complications, family issues, a desire to change residences, or a range of other factors.

Do you have options, with the exception of jumping back into the work-force? If you own your own home, the answer is yes! Depending on your circumstances, you may be able to borrow against the equity you have in your home.

What is home equity?

Simply put, equity is the difference between your home’s fair market value and the amount you still owe on your mortgage.

For example:

• You own a home that is worth $350,000.
• You have been paying off your mortgage diligently and now owe only $50,000.
• This means that you have $300,000 in equity in your home.

Why use your home equity when borrowing money?

There are a few ways that you can turn your largest asset into cash. But what are the advantages of using your home’s equity to get a loan rather than taking out an unsecured personal loan? There are several reasons why it can be a smart money move:

• Interest rates are often lower: Because these types of loans use your home as collateral, lenders can offer a lower interest rate.
• Repayment term is often longer: Repayment terms of a home equity loan, home equity line of credit, and cash-out refinance are often longer than those of personal loans. For borrowers, this means lower monthly payments.
• You can borrow more: Home equity gives you more money to work with compared to other borrowing options such as credit cards.

It’s also important to consider the risks associated with borrowing against your home equity. For instance, with a home equity loan, home equity line of credit, or cash-out refinance, you risk losing your home if you are unable to make payments.

How to Use Home Equity in Retirement

So what should you do with your home equity in retirement? One of these three options might fit your needs.

1. Reverse Mortgages

With a reverse mortgage, also known as a home equity conversion mortgage (HECM), you can borrow money based on your home equity but defer related mortgage payments (including interest) until you die, sell the home, or move out.

You may receive the funds in a lump sum, installments and/or in the form of a line of credit. You must pay for property taxes and homeowners’ insurance, but you can keep living in the home without making mortgage payments. In this case, the principal and interest on the HECM are simply added to the balance.

The lender recoups its costs when the home is sold at a future date. In some situations, the balance of the loan can exceed the home’s value before it’s sold. It’s important to talk with your lender and understand the financial consequences if this happens.

Qualifying for a Reverse Mortgage

To qualify for a HECM, you must be at least 62, live in the home that will serve as collateral, and own it outright or carry a minimum balance that will be paid at closing.

Before entering such an agreement, you will often be required to attend mandatory counseling to ensure the terms are clearly understood. The out-of-pocket administrative cost of securing a reverse mortgage loan may run between $800 and $900.

2. Home Equity Loans and Home Equity Lines of Credit (HELOCs)

These two options are very similar, but have one distinct difference.

• The funds from a home equity loan are deposited as a lump sum, much a traditional home mortgage.
• With a home equity line of credit, you will be approved for an amount upfront, but you only borrow funds as you need them. You will only be charged interest against the amount that you actually borrow.

For each type of loan, the interest rate may be fixed or variable. Both can be relatively easy to secure. The interest on these loans may be tax-deductible under federal— and some state— income tax laws.

However, both of these loans use your home as collateral, meaning if you’re unable to make payments, you may be faced with foreclosure. This is something to consider carefully as you look at your retirement spending, planning, and future needs.

Qualifying for a Home Equity Loan or Home Equity Line of Credit

These loans are available for homeowners of all ages. The intervals, terms, and available amounts will depend on factors such as the lender, your home’s value, your income, your credit rating, and your existing mortgage and debt.

In Texas, you don’t have to own your home outright to take out a home equity loan. However, you cannot borrow more than 80% against your home’s appraised value.

3. Cash-out Refinancing

This option allows you to replace your existing mortgage with a bigger refinanced mortgage — ideally at a lower interest rate — that includes an additional lump sum of money for you to use for other expenses.

The terms depend on your home value, your credit history, your ability to pay off the new debt, and the lender’s guidelines for refinancing. There will be new closing costs due (since this is a new loan), and you’ll also lose equity in your home after this process. And like a home equity loan, if you fail to make your monthly payments, the bank may take your home.

Qualifying for a Cash-out Refinance

A cash-out refi is available to homeowners of all ages. To qualify:

• You must meet specific credit and income requirements that are typically more stringent than those for reverse mortgages.
• Texas law states that you must have at least 20% equity in your home to take advantage of the cash-out.
• Texas law also caps the maximum loan-to-value (LTV) ratio that you can obtain for a primary residence at 80%. This means that the biggest mortgage you can receive is 80% of the total value of the home.

Take Advantage of Your Equity

In today’s economy, consumers can expect several options for securing extra money based on the equity in their homes — particularly if they’re of retirement age. Before making a decision, be sure to talk to a financial advisor. They can help you weigh the pros and cons of each home equity option before deciding which one works best for your needs.