A HELOC should not be treated like a piggy bank. The biggest risk is if you don’t make payments, which puts you at risk of default and losing your home to foreclosure. But it’s a good financial option, say personal finance professionals, in limited situations. Using a line of credit may be appropriate for homeowners doing expensive renovations or upgrades that allow them to stay in their home and nestle in place, especially on projects that don’t have a specific timeline. . You can also use a HELOC to pay off credit card debt with much higher interest rates or as an emergency fund if a large or unexpected expense causes a short-term cash flow problem. A HELOC “gives you flexibility and options,” McBride says.
Why getting a HELOC just got harder
While a HELOC can provide a much-needed financial safety net, getting a line of credit on your home isn’t as easy as it was before the pandemic. For one, many large banks, including Wells Fargo, JPMorgan Chase, and Citi, stopped issuing HELOCs in 2020 due to the economic uncertainty caused by the coronavirus, and they have yet to resume issuing them. to propose. Plus, without a regular paycheck to show their income, retirees often have a harder time qualifying for loans.
Even so, getting an approval is doable. Retirees with strong credit scores and high home equity can report income from sources such as pensions, Social Security, regular retirement savings withdrawals, and investment income, such as income from location,” says Isabel Barrow, director of financial planning at Edelman Financial Engines. But “it may mean more hoops to jump through,” adds Barrow.
Benefits of a HELOC
A HELOC is a handy personal finance tool. Here are a few ways it can help your bottom line.
Gives you access to a lump sum
Finding a large sum of money for an unexpected home repair can be a setback for many retirees. Foundation repairs can cost up to $40,000, a complete roof replacement can cost upwards of $11,000, and a new air conditioning system can set you back $12,500, according to personal finance app SoFi. In 2020, the average household spent $13,138 on home repairs, according to SoFi. “It’s a big chunk of change,” observes McBride. “Most retirees don’t have that kind of money left over.” A HELOC also gives you access to the cash accumulation in your home without having to refinance it, helping you avoid the higher closing costs of new mortgages.
Helps you avoid draining retirement accounts
A key to financial security in your golden years is to make sure your retirement savings accounts, such as 401(k)s and IRAs, can provide the income you’ll need for decades. One way to increase your chances of never running out of money is to avoid selling assets like stocks during market downturns. The reason? You will have fewer stocks to take advantage of if the market rebounds. This is where the HELOC shines. “Having a HELOC can mitigate asset pullback in a bear market,” McBride says. Instead of having to withdraw $40,000 or more from your 401(k) in a down market to fix your home’s foundation, for example, you can access that big lump sum through your HELOC. “If the market drops 20% within six months of retirement, you’ll be happy to have a home equity line of credit in place,” notes McBride. “You can lean on that a bit, rather than withdrawing money from your 401(k), and give your wallet more time to recover.” The big financial benefit? “It doesn’t automatically bleed your retirement account,” McBride says.
Offers tax benefits
Keep in mind that if you’re over 59½, any money you take out of a traditional 401(k) or IRA (funded with pre-tax dollars) is taxed at your income rate. For example, if you’re in the 12% tax bracket, you’ll face an estimated $4,800 tax bill on the $40,000 HELOC withdrawal, further eroding your 401(k).
By tapping on your HELOC, you avoid a financial transaction that will trigger a tax event. “Instead of withdrawing from your investment accounts and possibly increasing your taxes on retirement withdrawals or capital gains from a non-retirement account, you can tap into your investments over time to pay off your HELOC. “, says Barrow.
In some cases, you can also deduct the interest you pay on your HELOC. According to the IRS, interest paid on a HELOC is only deductible when you use the proceeds to buy, build, or significantly improve the home securing the loan. For example, “interest on a home equity loan used to build an addition to an existing home is generally deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not generally deductible. are not,” says the IRS. According to the IRS, you can deduct mortgage interest on the first $750,000 ($375,000 if you’re married and filing separately) of debt. But higher limits ($1 million or $500,000 if you’re married and filing separately) apply if you deduct mortgage interest on debt incurred before December 16, 2017.
Provides more flexible repayment options
The best personal finance plans have built-in leeway when money-related crises arise. And a HELOC offers a number of benefits to owners. “It allows them to borrow only what they need and only pay interest on what they have borrowed,” says Barrow. “You can repay interest only or pay interest and principal on your own schedule and schedule.” More importantly, it gives you additional control over when you draw down your retirement assets to pay back the money you’ve borrowed. Paying off your HELOC will be much easier when stocks rebound, allowing you to generate income while selling fewer stocks.
Dangers of using a HELOC
Like any loan, a HELOC must be repaid – with interest. And because your home is collateral for the line of credit, you need to make sure you have a repayment plan in place. You don’t want to dig yourself a bigger hole. “It could put your budget in an awkward position,” says Lower’s Lindenmuth. Interest rate risk is one of the biggest dangers of choosing a HELOC. Since most HELOCs have a variable interest rate, during periods of rising rates, like what economists are now predicting, your payment will also rise.
“The money you borrow today at 4% could be 5% or 6% a year later,” McBride says.
The Bottom Line: Don’t treat your HELOC like an ATM. Only borrow what you can afford.
Adam Shell is a freelance journalist whose career spans financial markets reporting to USA today and Investor’s Business Daily and as associate editor and writer at Kiplinger’s personal finances magazine.