Should Retirees Use Their Home to Pay Bills?

Retirement planning involves years of saving, but what happens if your nest egg falls short when the time comes? Your home could be a valuable asset, providing a means to cover medical bills, urgent repairs, or other expenses without depleting your savings.

Indeed, your home’s value has never been more potent. With soaring home prices, the average homeowner now holds a near-record amount of home equity. Baby Boomers, particularly those aged 60-78 who are nearing or in retirement, possess the largest homeownership stake, totaling an impressive $18.6 trillion in real estate wealth.

“Home equity represents wealth. It’s savings. For most Americans, it’s the most significant form of wealth,” explains Shoji Ueki, head of marketing and analytics at Point, a provider of home equity investments. “It allows any American, especially seniors, to meet life’s expenses and enjoy their lives. It can be a crucial tool in achieving these goals.”

However, before tapping into your home as a financial resource, it’s essential to carefully consider the potential benefits and risks. Let’s explore whether retirees should use their homes to cover expenses and the best approaches to consider if they decide to do so.

Your home equity represents the portion of your home that you fully own. Initially, when purchasing a home, your equity is equivalent to the down payment you put in, while the remainder is covered by your mortgage. Until the mortgage is fully paid off, your lender retains ownership of most of the property. However, with each mortgage payment, your ownership stake increases, and the lender’s diminishes gradually.

Assuming timely payments and stable property values, your equity grows over time. Increases in property values and home prices can further boost your ownership stake.

When you sell your house, your home equity is converted into cash. Yet, there are ways to leverage this equity for immediate funds while still residing in the home — a strategy particularly advantageous for retirees (though available to any homeowner meeting specific requirements).

The amount you can borrow against your home depends on your equity and how much is left on your mortgage.

Typically, lenders require you to own at least 15 to 20 percent of your home to borrow against it. They also consider the loan-to-value (LTV) ratio, which compares your loan amount to your home’s value. Building substantial equity takes time, but retirees, who may be nearing the end of their mortgage or have paid it off entirely, often meet these requirements more easily than younger homeowners.

To increase your chances of approval, maintain a history of timely payments, possess a good credit score (preferably above 700), demonstrate adequate income and stable employment, and keep your debt-to-income (DTI) ratio below 43 percent.

Utilizing home equity involves borrowing against the value of your ownership in the property. There are various methods to access this equity.

A home equity loan and a home equity line of credit (HELOC) are two common options for accessing home equity.

The main difference between them lies in how you receive and repay the funds. With a home equity loan, you receive a lump sum upfront, which you repay at a fixed interest rate over a set term, typically ranging from five to 30 years.

In contrast, a HELOC operates as a revolving line of credit. During an initial draw period, usually around 10 years, you can withdraw funds as needed, similar to using a credit card. Interest rates on a HELOC are typically variable, and after the draw period ends, you’ll enter a repayment phase where you pay back the borrowed amount.

If you still have a mortgage, another way to tap into your home equity is through a cash-out refinance. This process involves replacing your current mortgage with a new one that is larger. The new mortgage includes the remaining balance of your original loan plus an additional amount that represents a portion of your home’s equity, which you receive as cash.

If you’re 62 or older, you might explore a reverse mortgage to access your home equity. With this arrangement, your lender provides you with monthly payments, which are tax-free income (hence the term “reverse”). The loan needs to be repaid when you pass away, sell your home, or permanently move out. However, it’s important to note that reverse mortgages involve fees and accrue interest, which can increase your debt over time.

There are also home equity investment companies that offer a shared equity agreement, allowing you to borrow cash and repay it when you sell your house. In this arrangement, the company buys a stake in your home rather than issuing a traditional loan. Instead of charging interest, they typically share in the appreciation of your property’s value.

“You get some of the same benefits of accessing your home equity, but in a more flexible way because our credit score and income requirements are less stringent compared to a HELOC or home equity loan,” explains Ueki from Point, a provider of such agreements.

In each scenario, your home equity serves as collateral for the funds received, similar to how your home secured your original mortgage.

Using your home equity can be a convenient and cost-effective way to borrow significant amounts at favorable interest rates. Whether for medical expenses, tuition bills, or other financial needs in retirement, tapping into home equity can serve various purposes. Here are some common uses:

  • Emergency Expenses: If faced with unexpected costs and lacking an emergency fund, leveraging home equity could be considered. However, due to the time it takes to access funds, this may not be ideal for urgent needs.
  • Home Improvements: Whether for functional upgrades or aesthetic enhancements, home equity can fund remodels, repairs, and renovations. Beyond enhancing comfort and enabling aging in place, such improvements can increase property value. If used for home-related upgrades, the interest on these loans may be tax-deductible.
  • Debt Consolidation: Using home equity to consolidate high-interest debts, such as credit card balances, can save on interest costs. Home equity loans and HELOCs typically offer lower interest rates compared to credit cards.
  • Education Expenses: Funding a child or grandchild’s college education, including tuition, housing, and other costs, can be supported using home equity.

While these uses focus on covering expenses, there are also proactive uses for home equity, such as investing or acquiring additional assets like a second home. However, taking on debt or increasing existing debt to build wealth carries risks. For instance, acquiring a second home could result in three mortgages (two on the primary residence and one on the new property), and interest on the home equity loan used for the second home may not qualify for tax deductions. Thus, careful consideration and financial planning are crucial before using home equity for investment purposes.

Accessing your home’s equity can seem like a financial lifeline, especially in times of cash flow strain. However, it’s important to remember that with home equity loans, you’re essentially borrowing against your home’s value.

“People should exercise caution when using home equity to pay certain bills,” advises Lori Trawinski, Director of Finance and Employment at the AARP Public Policy Institute. “For instance, if you have significant credit card debt, which is unsecured, contrasted with secured debt like home equity loans. If you struggle to make payments on a home equity loan, your home may face foreclosure, putting it at risk of loss.”

Unless you’re prepared to return to work, repaying a loan becomes more challenging for retirees with limited income and earning potential. It’s worth noting that Social Security constitutes the primary income source for individuals aged 65 and older, with the average monthly retirement benefit totaling just $1,905 as of December 2023.

Trawinski advises potential borrowers contemplating a home equity loan to assess their income, establish a budget, and prepare for unforeseen circumstances.

“This could involve preparing for a major illness requiring additional funds for medical expenses,” she explains. “Or it could involve a reduction in household income due to the loss of a spouse. If such events were to occur, would you still be able to manage mortgage or home equity loan payments? Planning ahead is crucial, even though contemplating unpleasant scenarios is often avoided.”

It’s crucial to carefully consider the reasons and methods behind tapping into your home equity. If you’re using it to consolidate high-interest debt, it’s essential to have a disciplined spending plan in place. Otherwise, accumulating new credit card debt alongside the obligations of a new loan payment could lead to deeper financial challenges.

Similarly, if you access your equity without a specific purpose, you might find yourself using the funds for everyday expenses — a potentially risky path. “With a HELOC, your payments rise as you draw on it, which can be counterproductive if you’re seeking income but also increasing your monthly expenses,” explains Mason Whitehead, branch manager at Churchill Mortgage in Dallas.

While home equity loans generally offer lower interest rates compared to personal loans, retirees might not qualify for the most favorable rates.

Lenders are prohibited from discriminating based on age. However, research indicates that older homeowners often face higher costs and a greater likelihood of loan denials compared to younger applicants, potentially influenced by their age. Despite typically having higher average credit scores and more home equity, lenders may perceive older borrowers as riskier due to concerns about loan repayment if the borrower passes away before the loan term concludes.

Even if you can manage the repayments, it’s important to consider that borrowing against your home equity diminishes the value of a valuable asset—transforming something you own into a debt. According to a recent Fannie Mae survey of homeowners aged 60 and older, a majority expressed reluctance to use home equity for additional retirement income, with many preferring to own their homes outright.

Indeed, having home equity debt can complicate matters when it comes time to sell your home, as these debts, like mortgages, typically need to be settled immediately upon property transfer, reducing your net proceeds. Additionally, home-secured debts can pose challenges for your heirs if you intend to leave them the property (see below).

imilar to a mortgage, home equity debt persists after your death as a lien on the property, regardless of the new owner. Typically, your lender may require the debt to be settled promptly upon your death, often through the sale of the home or potential foreclosure if obligations aren’t met.

However, there are protections in place. Home equity loans, categorized as second mortgages, fall under the Garn-St. Germain Act. This legislation mandates that lenders collaborate with heirs or co-borrowers to assume loan responsibilities and maintain ownership of the home.

If you had credit life insurance or mortgage protection when securing the home equity loan, any outstanding balances should be covered by your policy, directly reimbursing the lender.

Reverse mortgages operate under distinct rules. Surviving spouses who are co-borrowers can continue receiving payments and reside in the home without immediate repayment obligations. Non-borrowing spouses may also qualify to remain based on when the reverse mortgage originated and specific eligibility criteria.

Once the last borrower or non-borrowing spouse passes away, heirs have choices such as settling or refinancing the loan, selling the home at a minimum of 95% of its appraised value, or opting for a deed in lieu of foreclosure. Whitehead suggests, “If equity remains in the home upon death, heirs can sell or refinance the property to access that equity, potentially securing a traditional mortgage if eligible.”

Navigating these complexities emphasizes the importance of effective estate planning for retirees managing home equity debt. Whitehead stresses, “Every borrower should have a will/trust or estate plan in place—regardless of assets—since state probate without one is lengthier and costlier. The estate inherits the home upon death, with remaining equity belonging to the estate and heirs.”