What Role Can Home Equity Play in Your Retirement Plan
In an ideal world, when the time to retire comes, you would have enough funds, including your savings and investments, to live comfortably while fulfilling your retirement goals. But life happens, so along the way your financial plan might have become upset due to situations that required you to dip into your savings and other funds. However, if you have equity in your house when you retire, it can be used to make up for the shortfall in or further enhance a sound financial plan.
There are three main ways to use your home equity- borrow against a property, reverse mortgage and downsize. Each method comes with its own pros and cons and landing on an option requires weighing your needs against requirements of each plan. Let’s take a detailed look at each option below to see what suits you.
Borrowing Against Your Home
Borrowing against the equity that you have in your home to get cash in your bank is called home equity line of credit (HELOC).
HELOC is a line of credit so it works more like a credit card than a home loan, except with much lower interest rate than a credit card. You don’t get the money in a lump sum, but you can withdraw the funds from your HELOC account as and when needed and you only pay interest on the amount you have withdrawn or used. If left untouched in your HELOC account, you don’t pay any interest, but the money stays there for you to use.
HELOC is easier to qualify for than an unsecured loan or line of credit as you are using your home as collateral. The amount you qualify for depends upon the equity you have in your house and you can get as much as 65% of that amount as a line of credit.
Your income is a very important factor in securing a HELOC as you only qualify if your income is sufficient to make minimum payments covering the interest each month. Therefore, it’s best if you apply pre-retirement, as your income and your credit score will be used to make the lending decision. However, if your post-retirement income is not less than before or otherwise sufficient, then you can take this decision anytime.
Taking a Reverse Mortgage
The name says it all; the reverse of the ordinary mortgage- a reverse mortgage is a loan that allows you to get money from your home equity without having to sell your home. This is sometimes called “equity release”. You may be able to borrow up to a certain percentage of the current value of your home.
This is usually the recommended route for older homeowners and the pro is that no payments are required on the debt until the house is sold or the owner passes away. However, there are cons to this option- the interest rate is higher than on a traditional loan and the compounding interest will decrease your home equity value. Therefore, this is the last recommended route.
Downsizing Your Home
Sell your property and pocket the cash- it’s as simple as that. There are things to consider of course. Looking at your lifestyle and your planned retirement goals-would you want to move somewhere smaller or stay in that family home for as long as possible, would moving hamper your social life etc.
However, if moving is the right choice for you, then there are several benefits. You get ready cash to use for your financial goals and retirement lifestyle. The equity is liquidated which can further be used for good investments, if you would like that. Depending on the jurisdiction, you might not even pay taxes on the capital gains from your primary residence.
Home equity can be very useful in your retirement if the need does arise. What’s right out of the above options depends on the individual circumstances in each case.
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