By Jasmin Brown, BDO First Call Debt Solutions

BDO First Call Debt Solutions

What you should know about home equity credit as you approach retirement

Jul 28, 2020 | 2:18 PM

Home equity loans are among the fastest growing forms of personal debt in Canada, and surprisingly, very common for homeowners in their 50s. Home equity credit can be used to finance a large expense like a home repair or vehicle purchase. And in uncertain times like these, a home equity loan might also be used to bridge an income gap if you’re facing reduced income due to COVID-19.

For Canadians in their 50s, who are more likely to have paid off all or most of their mortgage, a home equity loan may seem like a good option. Without precautions in place, though, reliance on home equity debt can lead to problems.

Are you thinking of borrowing against the equity in your home? Here is what you need to know beforehand.

Retirement is in sight – why add home equity debt now?

You are approaching retirement, you have been paying down your mortgage for years, now is the time to take out a home equity loan…or is it? The impulse to open a Home Equity Line of Credit (HELOC) to help you cover costs during a crisis may seem like a sound idea.

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According to a 2019 survey, 63 per cent of HELOC debt comes from Canadian homeowners over 50. What’s concerning is that of that group of older homeowners, nearly a quarter are 65 or older. This can be risky. Here’s why:

· A HELOC usually allows you to make interest-only payments each month. This is convenient when your budget is tight, but it also means you are never truly paying down the principal balance.

· A HELOC’s credit limit increases automatically as your mortgage balance goes down. A growing credit limit can be a great source of temptation, quickly leading to unmanageable debt.

· HELOCs are almost always variable-interest loans, meaning the entire balance of your loan can increase as interest rates rise, making it much harder to repay.

· As you head into retirement, or if you are already there, you know that your top earning years are likely behind you. Paying back a large equity loan can add undue debt stress to your retirement budget, making it more difficult to afford everyday essentials in your later years.

· Servicing your HELOC could put some or all of your retirement savings and income at risk. An Equifax survey found that more and more seniors are defaulting or falling behind on their mortgages, loans and lines of credit because they just can’t cover all the costs. This is most likely when seniors borrow more than $50,000.

Alternate ways to borrow against home equity

Borrowing at any age comes with inherent risk, but the older you get, the more precautions you should take before taking on any debt. Some Canadians choose to use a home equity loan to consolidate high-interest debt. This can be a good strategy when combined with careful budgeting, reduced spending and a dedicated repayment plan.

However, since HELOCs have drawbacks specifically for older borrowers, here are alternative ways to borrow against the equity in your home:

Reverse mortgage – For Canadians over 55 whose finances have been negatively affected by the COVID-19 crisis, this option allows them to borrow against the equity in their home. A reverse mortgage can be taken as monthly income or a lump sum. Payments are not required and the principal and interest on the loan are paid when the home is sold or the homeowner dies.

Refinancing – When your mortgage is up for renewal, you can speak to your lender about including a home equity loan in your mortgage payment each month.

Prepaid borrowing – If you have ever put down extra money on your mortgage principal, you may qualify to borrow those amounts back in the form of a loan. As with the two above options, this can be wrapped up into your monthly mortgage payments. The key difference is that you do not need to pay any extra fees such as appraisal or title search.

How to make debt management a priority in your 50s

The last thing you want on your mind as you approach retirement is a mounting debt balance. And, you don’t necessarily need to turn to a HELOC or any equity loan in order to deal with it. If you have accumulated some loans, credit card debt or any personal debt, consider taking these steps to pay it back before you retire:

1. Stick to a budget. Lay out your monthly expenses, paying careful attention to areas where you are overspending. Now, think ahead to retirement. What will your budget look like based on your projected retirement income?

2. Live below your means if you can. Prepare yourself for retirement years by streamlining your spending now. Otherwise, your finances will have quite the shock when retirement begins, and you could end up turning to debt to make up the shortfall.

3. Consolidate your existing debt. Speak to your lender or a Licensed Insolvency Trustee. Or put in place a ‘DIY’ debt payment strategy like debt avalanche or debt snowball. You do not need to tap into your equity just to pay down debt. Check our repayment options calculator for additional debt relief options.

4. Keep saving. As you approach retirement, saving as much as you can should be a high priority. Try to balance saving and debt repayment to ensure you are ready for that clean financial slate when retirement comes.

5. Plan for emergencies. Expecting the unexpected means always having a backup plan. If you can, keep an emergency fund on hand at all times for home repairs, vehicle trouble or anything that comes up unexpectedly.

Learn more about healthy debt repayment habits by joining the conversation on Twitter and Facebook.