Don't Blow Your Retirement Using Your House Like a Piggy Bank

Your home equity could keep you afloat in retirement or bail you out in an emergency — but not if you spend it first.

U.S. homeowners are sitting on nearly $6 trillion of home value they could tap as of May 2018, according to data provider Black Knight. Lenders are eager to help many do just that through home equity loans, home equity lines of credit and cash-out refinancing.

The rates are often lower than other kinds of borrowing, and the interest may still be deductible, despite last year’s tax reform changes. But you can lose your home to foreclosure if you can’t pay back the loan, which is why financial planners generally frown on using equity for luxuries, investing or consolidating credit card debt.

Many planners point to the foreclosure crisis that started a decade ago as an example of what can go wrong when people binge on home equity debt.

“Having equity in your home is a huge financial advantage that can provide for significant flexibility, security and peace of mind,” says Howard Pressman, a certified financial planner in in Vienna, Virginia. “It is not an ATM that can be used to supplement your lifestyle.”

YOU MAY NEED THAT MONEY LATER

Retirement experts predict many Americans will need to use home equity to support them when they stop working. They may do that by selling their homes and downsizing or by using a reverse mortgage, which doesn’t require payments. Reverse mortgages give people 62 and older access to their equity through lump sums, lines of credit or a series of monthly checks, and the borrowed money doesn’t have to be paid back until the owner sells, dies or moves out.

Home equity also can be used to supplement emergency funds, planners say. Pressman recommends home equity lines of credit to his clients who don’t have debt problems and who are disciplined and won’t spend the money frivolously.

PUT YOUR OWN LIMITS ON BORROWING

Before the Great Recession, several lenders allowed people to borrow over 100 percent of their home’s value. These days, the maximum is typically 80 percent. (Black Knight used this 80 percent loan-to-value standard to calculate how much tappable equity people have, based on current home values and existing home loans. The answer: $5.8 trillion.)

Homeowners would be smart, though, to set their own limits lower to ensure they still have access to equity in an emergency and are able to pay off all of their mortgage debt before retirement.

IS THE POTENTIAL BENEFIT WORTH THE RISK?

Financial planners generally frown on using equity for luxuries such as vacations, high-risk ventures such as investing in the stock market or starting a business, or for debts that should be paid off more quickly. (The typical mortgage lasts 30 years, while home equity loans and lines of credit can stretch for 20 or more years.)

“If the money is being used to pay down credit cards or buy a car, then think twice about doing it at all,” says Monica Dwyer, a certified financial planner in West Chester, Ohio. “Those kinds of debts should be paid off in the short term, not with long-term borrowing.”

Many people use home equity to pay college bills for their kids, but planners urge caution since it’s easy to overspend on higher education. In general, parents shouldn’t borrow more for college than they can pay off before retirement, and the debt shouldn’t prevent them from saving enough for that retirement. Federal education loans may be a better option, since they have fixed rates and consumer protections such as forbearance and deferral.

Investing in home improvements can be a good use of home equity, financial planners say, as long as the projects add value to the home. (The IRS has said that interest on home equity borrowing may still be deductible if the taxpayer itemizes deductions and the money is used to “buy, build or substantially improve the taxpayer’s home that secures the loan.”)

Even then, Kristin Sullivan, a certified financial planner in Denver, likes her clients to have a plan to pay off the loan within five years. That’s “a reasonable time period to pay off something you don’t really need,” she says.