Since home equity makes up such a significant allocation of Canadian wealth, it is only natural to wonder how best to use this equity in retirement. Let’s look at three options for retirees: using a home equity line of credit (HELOC), taking out a reverse mortgage and selling your home.
HELOC rates in Canada
A HELOC is a simple and flexible way to spend your home equity. You can borrow as needed up to your credit limit and pay interest only on the balance borrowed. As a secured loan, the HELOC uses your home for collateral. Secured loans typically have lower interest rates than unsecured loans (such as personal loans and credit card debt). Currently, HELOC rates in Canada are about 5% to 6%.
Many people have lines of credit during their working years and use them for various purposes. Retirees and pre-retirees may think a line of credit is a viable option for them in retirement. There are two problems with this expectation.
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First, if someone wants to apply for a line of credit, they must meet the same criteria they would if applying for a mortgage. Amongst other considerations, the lender will evaluate the applicant’s borrowing capacity based on their income. Since incomes tend to be lower in retirement, a retiree’s credit approval may be limited. (Read Line of credit versus personal loan.)
A HELOC limit can generally be up to 65% of a home’s value, and a combined mortgage and HELOC balance cannot exceed 80% of the appraised value. But a borrower’s income will dictate how close to those upper thresholds the borrower might get.
Second, Canadians who are counting on using a HELOC in retirement may be surprised to learn that their credit limit may shrink. A lender can lower a HELOC limit, and it may do so for a variety of reasons. For example, home values have deteriorated recently, resulting in less equity to serve as collateral. Lately, I have seen a few cases of lines of credit being frozen or closed for non-usage and for retired home owners. Although you may not be required to repay the outstanding balance other than the regular monthly interest payments, the available credit limit could be reduced.
Closing a dormant HELOC could just be a bank’s way of reducing liability for a product that is not generating a profit. This appears to be more common with unsecured lines of credit and credit cards than with HELOCs.
Retired home owners—who are likely to have lower incomes than they did while working—are definitely at risk of having their limits lowered. Two of my clients recently had to provide documentation of their income as if they were reapplying for credit, resulting in a reduction to their borrowing limits.
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