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Sunday, February 5th, 2017

A better way to tap home equity

If you can’t live within your means in your working years, there’s no reason to believe you’ll pull it off in retirement.

So let’s start familiarizing ourselves with the options for retirees who didn’t save enough to live the kind of lifestyle they want. One is to go back to work. Easy to say, but hard to do unless you can consult or have an affinity for fast food.

Another is to rent out a basement apartment or sell the family home and either buy a cheaper house or rent. Moving is a non-starter for many retirees because they still enjoy their homes and want to have a place for kids and grandchildren to stay.

This brings us to two options for borrowing against the equity in your home, one of which, reverse mortgages, was covered last week (read that column here). The other option is the home equity line of credit, which a lot of people will set up and use long before they retire because it’s an efficient way to borrow.

For retirees, both a home-equity line of credit and reverse mortgage offer a way to borrow money and defer repayment – at least to some degree – until the family home is sold. The better choice for cash-strapped seniors is the credit line, although using one requires care and attention. In fact, you could argue that reverse mortgages are much lower maintenance.

A HELOC – that’s what the financial industry calls a home-equity line of credit – allows you to borrow up to as much as 80 per cent of the equity in your home at the lowest cost possible for the average person. HELOCs are typically priced at prime, which today is 3 per cent, plus 0.5 to 1 percentage point.

Borrowing costs are much lower with a credit line, partly because reverse mortgages charge higher interest rates and partly because there’s a big difference in the way interest is charged with these two borrowing tools.

With a reverse mortgage, you will not be asked to repay your debt in full until you sell your house, whenever that is. While this is certainly appealing if you’re a senior with a limited income, there’s a major downside. Interest applies not only to your principal, but to the unpaid interest that mounts up year by year.

Home-equity credit lines impose more discipline on you as a borrower and, in doing so, they save you money on interest. That’s because you can’t let the interest slide with a credit line. Each month, you have to at least pay the amount of interest you owe (principal repayment is optional). If you borrow $100,000 on a credit line pegged at 3.5 per cent, your monthly interest bill would be close to $300.

In a pinch, you could dip into your credit line to pay your monthly interest bills. But then you’d be in the same position as the reverse mortgage – paying interest on interest.

Home equity credit lines also differ from reverse mortgages in that they’re callable loans, which means a bank can, in some circumstances, demand that you repay what you owe in full. Vancouver mortgage planner Robert McLister said banks review client HELOCs on a set schedule, maybe every five years, and situations that might draw their attention include:

-The death of a spouse, in cases where both spouses have their names on the HELOC.

-Missed interest payments.

-A continual drawing down on a credit line over a period of many years with zero principal repayment.

Retirees will find it harder to qualify for home-equity credit lines than reverse mortgages, said Mr. McLister, who is editor of the Canadian Mortgage Trends blog. “With a line of credit, a bank will review your credit history, your income and whatnot – it’s like a full mortgage application. A reverse mortgage application is: Do you have a heartbeat and do you have [home] equity?”

If you do use a home-equity line of credit as a retiree, Mr. McLister suggests you limit your borrowing to 40 per cent of the value of your home. That way, you’re unlikely to run into a situation where your HELOC balance exceeds the value of your home in a falling housing market. If that does happen, the bank could ask you to pay off some of what you owe so that you’re back to an 80-per-cent ratio of loan to value.

Mr. McLister also suggested retirees borrow on a gradual, as-needed basis using a credit line. If they borrow too much too soon, they may not be able to afford the mandatory monthly interest payments.

One last tip: Arrange a HELOC while you still have a job. Banks are much less choosy about granting credit lines to working people than they are to retirees.

MORE RELIEF: THE PROPERTY TAX DEFERRAL
How it works

Seniors arrange to defer paying property taxes on their primary residence until they sell their home; in some cases, seniors may only be able to defer property tax increases.

Where to find it

On a city-by-city basis – check with municipal governments.

Qualifications

These programs are typically, but not always, aimed at low-income seniors; one spouse typically must be 55 or older.

Cost

A one-time administration fee and small annual renewal fees may be charged, and interest applies.

Note

You must pay your deferred taxes in full plus interest when you sell.

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