Many Americans have built significant wealth in their homes. In fact, the average mortgage holder has approximately $299,000 in built-up equity, according to analytics firm Cotality, and that doesn’t even account for those who have paid off their loans and own their homes free and clear.
For older homeowners, this accumulated equity may serve as a backup or supplemental source of retirement funds. But while home equity can be used to cover major expenses or fill retirement income gaps, doing so can be risky and may not be the right decision for all retirees.
In this article, we walk through how some homeowners might use their equity to fund retirement, when this strategy may or may not make sense, and the risks associated with taking on additional home equity debt later on in life.
Keep in mind that the concepts in this article are presented for educational purposes only and are not personalized financial advice. Be sure to consult a professional before making any retirement funding decisions.
What Does It Mean to Use Home Equity for Retirement?
Home equity is the value of your ownership stake in your home. You can calculate your built-up equity by subtracting your mortgage balance from your property’s current value.
For Example: If your property is worth $400,000 and you owe $100,000 on your mortgage, you have $300,000 in home equity.
In this scenario, if you sold your home at market value, $100,000 of the proceeds would satisfy your loan while you’d receive your $300,000 of equity, minus closing costs, as a lump sum.
However, lending options exist for seniors who want to access their equity without selling, such as:
- Home Equity Lines of Credit (HELOCs)
- Home Equity Loans
- Cash-Out Refinances
Unlike liquidating investments or withdrawing savings, tapping into home equity involves taking on additional debt. While some retirees or near-retirees might consider this option to improve liquidity or help with fixed income constraints, it’s crucial to understand the implications of adding debt, particularly if you don’t have a comprehensive plan for repayment.
Why Some Homeowners Consider Using Home Equity in Retirement
Borrowing against home equity can be an attractive option among retirement-age property owners as it provides access to a sizable asset while allowing them to remain in their home.
Some of the most common motivations for tapping into equity in retirement include:
- Supplementing income to maintain a pre-retirement lifestyle. Some financial planners estimate retirees may need roughly 70% to 80% of pre-retirement income to maintain a similar lifestyle.
- Paying for unexpected expenses, such as home repairs or health care needs
- Bridging income between retirement and when social security or pension benefits begin
- Consolidating other high-interest monthly debts to improve cash flow
- Covering living costs during market downturns when selling stocks may not be optimal
- Helping family members with major life expenses, such as college tuition or buying their first home
Ways Home Equity Is Commonly Used for Retirement Funding
As we noted earlier, homeowners can access their home equity in three primary ways: HELOCs, home equity loans, and cash-out refinancing.
Let’s take a closer look at each of these loan types and how they differ from each other.
Home Equity Line of Credit (HELOC)
A home equity line of credit is a type of second mortgage that exists alongside your current home loan, if you have one. With a HELOC, you can access your equity through a revolving line of credit that you use at your discretion throughout a multi-year draw period.
During this initial draw phase, you’re only obligated to make interest payments on the balance you’ve accumulated, typically based on a variable interest rate. Once the HELOC transitions into the secondary repayment period, your line of credit closes, and you make principal and interest payments to satisfy the loan.
Home Equity Loan
Home equity loans are another type of second mortgage, but instead of a line of credit, you receive an upfront lump sum of cash. Whereas a HELOC allows for interest-only payments during the early years, a home equity loan requires you to begin making principal and interest payments right away.
Unlike HELOCs, however, home equity loans generally have fixed rates, meaning your monthly payments remain consistent and predictable for the life of the loan. Both HELOCs and home equity loans can be beneficial as secondary liens if you already have a lower interest rate, since you’ll keep your current mortgage and add the new one.
For instance, if you currently have 2.5% mortgage, you may not want to refinance into today’s rates. Instead, it may be better to carry a secondary lien at 7 or 8% rather than a new mortgage at 5-6%. This option creates a lower combined or blended interest rate.
Use this Blended Rate Calculator to see if a secondary lien is better than a brand new mortgage!
Cash-Out Refinance
A cash-out refinance functions as a primary mortgage, replacing your existing home loan, while allowing you to access your equity as a lump sum upfront. As a first-position lien, cash-out refinance rates tend to be lower than HELOCs and home equity loans. However, closing costs are often higher if you wrap in your existing mortgage.
Most cash-out refinances offer fixed rates, though variable-rate options are available.
Should Retirees Consider a Reverse Mortgage?
Some retirees may also consider a reverse mortgage to access home equity without taking on traditional monthly loan payments. Reverse mortgages, commonly called Home Equity Conversion Mortgages (HECMs), are available to homeowners age 62 and older and allow borrowers to convert a portion of their home equity into cash.
Unlike a HELOC or a cash-out refinance, a reverse mortgage typically does not require monthly mortgage payments. Instead, the loan balance grows over time and is generally repaid when the homeowner sells the property, moves out permanently, or passes away.
While this can improve cash flow for some retirees, reverse mortgages come with important tradeoffs. Fees and interest costs can be substantial, and borrowing against your home this way reduces the equity available later on for downsizing, future care needs, or heirs. Borrowers are also still responsible for property taxes, homeowner’s insurance, and maintaining the home.
For some homeowners, a reverse mortgage may serve as part of a broader retirement strategy. However, it’s important to carefully evaluate the long-term costs and speak with a qualified financial professional before making a decision.
The Risks of Using Home Equity to Fund Retirement
Using home equity to fund retirement can be a risky strategy for some homeowners, and that risk tends to grow as income becomes more fixed.
Here are some of the biggest issues to consider before borrowing against your equity during retirement.
Financial Risks
Many homeowners who use their equity during retirement do so to supplement other sources of retirement income. This can lead to financial risks, such as:
- Increasing debt load during a period when income is already reduced
- Taking on long-term financial obligations that may last decades into retirement
- Exposure to changes in interest rates when using variable-rate equity products like HELOCs
Housing Risks
There are also a couple of housing risks to think about when using your primary residence as collateral:
- Borrowing against your home now will reduce your equity cushion, leaving you in a bind if you have a sudden, unexpected need for funds.
- If your payments become unmanageable and you fall behind on your loan, your lender could foreclose on your home.
Emotional Risks
Last but not least, there’s an emotional aspect of borrowing against your equity. Retirement is meant to be a time to relax, stress-free, and enjoy the golden years of life. Carrying debt into retirement, especially on your primary residence, can add stress to homeowners with limited fixed incomes.
When Using Home Equity Might Make Sense
While using home equity to fund retirement won’t be the right choice for everyone, some scenarios exist when doing so could make sense:
- Meeting short-term liquidity needs, such as between retiring from work and benefits beginning
- For homeowners with high remaining income or other considerable assets who use their home equity as part of a financial strategy rather than out of necessity
- When there’s a clear-cut plan for repayment, such as someone who plans to downsize within the next few years and can pay off the new loan with the proceeds from selling their home
It’s important to reiterate that, in most cases, using home equity should be a supplement to retirement income, not a foundational strategy for funding retirement altogether.
Everyone’s financial situation differs. It’s wise to seek individualized guidance from a financial professional before making any retirement funding decisions, especially if that means taking on additional debt.
When Using Home Equity Is Likely a Bad Idea
In many situations, it may be better to avoid tapping home equity during retirement, whether to fund retirement itself or to cover other expenses.
Here are some times when using your home equity is likely a bad idea:
- Relying on equity as your primary retirement income rather than supplementing it
- Using your equity to cover basic living expenses with no plan for repayment
- Borrowing when you have a very limited income, and the monthly payments could cause financial distress
- Taking on variable-rate debt when rates are rising, or you have a limited tolerance for increased payments
In these scenarios, accessing home equity may help in the short term but can often increase your overall financial instability in the long run.
Refinancing and Equity Access Considerations
Borrowing against your home’s equity, whether through a cash-out refinance or a second-position product like a HELOC or home equity loan, should be done as a part of a broader retirement planning strategy.
By tapping into equity, you’re typically going to:
- Increase your monthly payments at a time when you’re likely relying on a fixed income
- Extend the length that you owe on your home, sometimes by decades
- Open yourself up to interest rate risk when taking out a variable-rate loan, meaning your payments could rise suddenly and significantly
If you’re considering taking out a loan to access your home equity, be sure to check out the informative resources here on Refi.com to compare your options and better understand the costs and pros and cons of each.
Frequently Asked Questions
Here are answers to some of the most frequently asked questions about using home equity to fund retirement.
Can You Use Home Equity to Fund Retirement?
Yes, but doing so is not the same as selling an investment or using savings. Tapping into your home equity means taking on additional debt and comes with a variety of financial, housing, and emotional risks.
Is a HELOC a Good Retirement Strategy?
It can be a short-term solution in some scenarios. Still, variable interest rates and the associated repayment risk make HELOCs unsuitable for many retirees living on a limited fixed income. Since HELOC rates tend to be adjustable, they’ll most likely cancel out the rate of return from held investments.
Is Cash-Out Refinancing Safer Than a HELOC for Retirees?
Doing a cash-out refinance with a fixed-rate loan can provide more stable monthly payments that are easier to budget for. However, any mortgage product that accesses home equity increases your long-term debt, which inherently carries some risk.
Ready to Take the Next Step?
Home equity can play a role in retirement planning, but it should not serve as a substitute for savings, investments, and other retirement strategies. Before tapping into your built-up equity to fund your retirement needs, carefully weigh the risks, plan conservatively, and consult an experienced financial professional.
Always remember to explore your equity and refinance options responsibly. The resources available on Refi.com can help you understand the risks, costs, and tradeoffs associated with borrowing against your home’s equity.
