Your Home and Your Retirement Part 2

A HELOC can supplement retirement income

“Your home should not be your retirement.” This is a common headline in personal finance and it can give the wrong impression - that you shouldn’t rely on the equity in your home to fund your retirement.

The rationale for this advice is twofold: first, that you will always need a place to live and the value of your home will be needed to buy or rent another residence, and second, that you need money to buy food and other things, which you can’t do if all your wealth is tied up in your home.

Both these points are valid, but they don’t apply to everyone. Like all aspects of financial planning, each individual’s personal circumstances need to be considered and in fact, many people should count on their home to help fund their retirement.

Your home as a source of cash

As I demonstrated in a prior blog post, for those in high-priced housing markets like Toronto, the proceeds from selling a mortgage-free home will likely more than offset the cost of renting for 30 years in retirement, including paying for long-term care. Ditto for downsizing to a smaller place. This means there could very well be excess funds that can be used later in life and this should be accounted for when determining how much retirement savings you need.

What about the second point, that you need cash to fund your expenses? To address this problem, using a home equity line of credit (HELOC) is a viable option.

It’s a common conundrum for home owners: they want to retire (or semi-retire) but don’t want to sell their home. Maybe one day they will, but they can’t say for certain when. Do they have to keep working full-time in order to pay their expenses or to save more? Not necessarily. They can access the equity in their home using a HELOC.

A HELOC is a completely flexible product. It allows you to borrow money any time you want and repay it when you want. You do have to make at least interest-only payments every month, but other than that, the limitations are few. It’s also very easy to access, as you can transfer funds back and forth between the line of credit and your chequing account online. The interest rate is variable and based on the prime rate, often prime plus 0% to 1%. Since the prime rate is currently 4.7%, a HELOC rate is around 4.7% to 5.7%.

Using a HELOC in retirement is a valuable option to have. If you think you will want to retire or semi-retire well before you sell your home, secure a HELOC on your home before you leave the workforce. Many people with a mortgage have a HELOC already, so make sure you hang onto it when you make you pay off your mortgage because it may be harder to be approved for one once you retire.

Debt in retirement?

What about the adage that you shouldn’t carry debt into retirement? Being debt-free is always a nice thing, especially to be free of credit card debt. However, borrowing from your HELOC knowing that you will easily be able to repay it when you sell your house (and especially if it's only for the first part of your retirement) is very different, as long as you are borrowing and spending responsibly.

What’s the alternative? If you don’t want to borrow from your HELOC but are still living in your home in retirement, you might deprive yourself of quality of life if your budget is very tight, not being able to enjoy the wealth you have accumulated. And you will end up leaving a large amount of equity (the value of your house) in your estate. Is that what you want to do? If so, make it a conscious choice, not a side-effect of being tied to the idea that you shouldn’t borrow money in retirement.

An example

Let’s assume you retire at age 65. You live in a home worth $1.2-million and your mortgage is paid off. You begin collecting CPP and OAS. You have some money in an RRSP and a TFSA, but haven’t saved enough to give you the annual income you want, which is $60,000 a year before tax.

Over the first 10 years of retirement, you borrow from your HELOC to supplement your income. In this example, you would end up borrowing about $289,000 over ten years for a total interest expense of $75,000 (assuming a 5% interest rate). When you sell your home at age 76, you will net roughly $1.4-million from the sale, assuming house prices rose at 2% per year, and after paying off your HELOC are still left with $1.1-million, more than enough to pay your rent for the rest of your life. In the meantime, you have not depleted your RRIF account.

As always, there are risks with using a HELOC but applying common sense will show that the risks are minimal. What could derail this strategy? The value of your home plunging 75% (making your loan equal to the value of the house), interest rates skyrocketing to 15% and staying there for 10 years (causing interest costs to rise to $320,000 over the life of the loan), or the bank calling the HELOC early (if you are persistently delinquent on the loan).

Using credit should never be taken lightly but with proper analysis and planning, using a HELOC might allow you to retire or semi-retire earlier and have a higher standard of living in retirement.