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Why You Might Need a Home Equity Line of Credit And Why You Might Not Get One

Sometimes, you might not want to take the cost of a big repair from your retirement savings

Home equity line of credit HELOC documents.
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If you’re a retiree and own a home, you’ve likely come into a windfall while cooking in your kitchen or watching TV in your family room. Thanks to a real estate boom, home prices rose 20 percent between February 2021 and February 2022, according to CoreLogic, a property analytics company. And if you own a residence in a warm-weather locale, like Florida or Arizona, the average year-over-year price increase was even bigger, with gains of 29.1 percent and 28.6 percent, respectively. ​

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That means the equity in your home (the market value of your property minus what you owe on mortgages) is on the rise, too. Tappable home equity — the amount of money homeowners can access while still retaining at least 20 percent equity in their home — surged 35 percent in 2021, to a record $9.9 trillion, according to data and analytics provider Black Knight. That equates to $185,000 in equity for the average mortgage holder. ​

The rise in real estate wealth, however, has come at a time when prices for food, gas, cars and other consumer goods have gone up significantly, thanks to the highest inflation in 40 years. Stock market weakness early this year may also have put pressure on retirees’ portfolios, making it a less desirable time to withdraw funds. ​

So how can you take advantage of the cash piling up in your home without selling it? A home equity line of credit, or HELOC.

Personal finance pros say it’s prudent to have a line of credit in place so you can get cash in an emergency or cover a large purchase that would otherwise drain long-term retirement accounts. If you don’t have a HELOC, it’s a good idea to get one before a cash crunch strikes, says RJ Lindenmuth, senior vice president of refinance at mortgage lender Lower. “The ideal move is to get the HELOC before you need it.”​

The ABCs of a HELOC

A HELOC is a type of home equity loan that typically carries a variable interest rate, which means your rate can rise if the Federal Reserve hikes interest rates. (Its cousin, a home equity loan, comes with a fixed rate and fixed amount, like a regular mortgage.) A HELOC is a second mortgage that works like a credit card and gives you access to a credit line that you can draw on when you need it by writing a check or using a credit card issued by your lender.

Lenders will typically let you borrow up to 80 percent of your home’s value, although some allow higher loan-to-value ratios. Most HELOCs have a 10-year draw period in which you can tap funds and have an interest-only payment option on the amount you spend. You then have up to 20 years to pay back both the principal and interest. ​​HELOCs generally have lower rates than home equity loans, personal loans and credit cards, according to Bankrate.com. Currently, the average rate for a HELOC is 3.95 percent, according to Greg McBride, chief financial analyst at Bankrate. But the Federal Reserve is signaling six more quarter-point rate hikes this year, and borrowing costs will adjust higher in the months ahead. ​

A HELOC shouldn’t be treated as a piggy bank. The biggest risk is if you fail to make payments, putting you at risk of defaulting and losing your house to foreclosure. ​But it’s a good financial option, personal finance pros say, in limited situations. Tapping a line of credit may be appropriate for homeowners doing expensive renovations or improvements that allow them to stay in their homes and nest in place, especially during projects that don’t have a firm timeline. You can also use a HELOC to pay down credit card debt with much higher interest rates or as an emergency fund if a big or unexpected expense causes a short-tern cash problem. A HELOC “gives you some flexibility and options,” McBride says.​

Why getting a HELOC has gotten tougher

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Although 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 because of economic uncertainty caused by the coronavirus, and they have yet to start offering them again. What’s more, without a steady paycheck to show income, retirees often have a tougher time qualifying for loans.

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Even so, getting approved is doable. Retirees with solid credit scores and ample equity in their homes can report income from sources such as pensions, Social Security, regular retirement savings withdrawals and investment income, like rental income, explains Isabel Barrow, director of financial planning at Edelman Financial Engines. But “it may mean more hoops to jump through,” Barrow adds.

Advantages of a HELOC

A HELOC is a handy personal finance tool. Here are some ways it can help your bottom line.

Gives you access to a lump sum

Coming up with a big chunk of money for an unexpected home repair can be a nonstarter for many retirees. The cost of fixing the foundation can run as high as $40,000, a full roof replacement can be more than $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, SoFi says. “It’s a big chunk of change,” McBride observes. “Most retirees don’t have that kind of money sitting around.” A HELOC also gives you access to cash building up in your home without having to refinance it, which helps 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 downdrafts. The reason? You’ll have fewer shares to take advantage of an eventual market rebound.​​ That’s where the HELOC shines. “Having a HELOC can alleviate having to withdraw assets in a down market,” McBride says. Instead of having to remove $40,000 or more from your 401(k) in a falling market to fix your home’s foundation, for example, you can get access to that big lump sum via your HELOC. “If the market falls 20 percent in the six months after retirement, you’ll be glad you have a home equity line of credit in place,” McBride notes. “You can lean on that for a little bit, rather than pull money out of your 401(k), and give your portfolio more time to recover.”​​The big financial upside? “It doesn’t automatically bleed your retirement account,” McBride says.

Offers tax-savings benefits

Keep in mind that if you’re older than 59 ½, any money you withdraw from a traditional 401(k) or IRA (funded with pretax dollars) is taxed at your income rate. For example, if you are in the 12 percent tax bracket, you’ll face a $4,800 estimated tax bill on the $40,000 HELOC withdrawal, which further erodes your 401(k).

​By tapping your HELOC, you avoid a financial transaction that will trigger an income-tax event. “Instead of drawing off of your investment accounts, and possibly increasing your taxes on retirement withdrawals, or capital gains from a nonretirement account, you can draw from your investments over time to pay back your HELOC,” Barrow says.​

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In some instances, you can also deduct the interest you pay on your HELOC. According to the IRS, interest paid on a HELOC is deductible only when you use the proceeds to buy, build or substantially improve the home that secures the loan. For instance, “interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not,” the IRS says. You can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtedness, according to the IRS. But higher limitations ($1 million, or $500,000 if married filing separately) apply if you are deducting mortgage interest from indebtedness incurred before Dec. 16, 2017.​

Provides more flexible repayment options

The best personal finance plans have wiggle room built into them when money-related crises arise. And a HELOC offers a number of advantages to homeowners. “It allows them to borrow only what they need and only pay interest on what they have borrowed,” Barrow explains. “You can pay back interest only or pay interest and principal down on your own schedule and timeline.” More importantly, it gives you extra control over when you draw down your retirement assets to repay the money you’ve borrowed. Repaying your HELOC will be a lot easier when stocks rebound, allowing you to generate income while selling fewer shares.​​

Dangers of using a HELOC

Like any loan, a HELOC needs to be paid back — with interest. And because your home is the collateral for the credit line, you must 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 uncomfortable place,” 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 increase, too.​

“The money you borrow today at 4 percent could be 5 percent or 6 percent a year down the road,” 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 work as a financial market reporter at USA Today and Investor’s Business Daily and as an associate editor and writer at Kiplinger’s Personal Finance magazine.

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