Buyer Beware: The Top 5 HELOC Risks for Retired Homeowners

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A home equity line of credit (HELOC) offers convenient access to home equity, but it comes with risks for retired homeowners living on a fixed income. We’ll explain the top 5 HELOC risks you need to be aware of before applying for a HELOC in retirement.

The Prevailing Wisdom

I’ve talked with many retirees over the years who either had a HELOC already or were planning to get one to supplement their income and/or provide cash for unexpected expenses.

Many of them checked into a HELOC because of recommendations from CPAs, attorneys, financial advisers, or family members.

Many financial pundits and commentators promote HELOCs to retirees. Check this out from Money.com (emphasis mine):

Taking out a loan as a senior may seem counter-intuitive, but there are reasons to consider it. Getting a home equity loan or line of credit (HELOC) as an older homeowner can bolster your retirement income, provide opportunities for additional income streams, increase the value of your home or help add comfort as you age in place.

Source: Money.com

Or this from CBS News (emphasis mine):

Home equity loans and HELOCs are attractive options for homeowners of all ages, but they’re arguably the most beneficial for seniors. Because of their low interest rates and tax benefits, they’re often the most cost-effective and reliable way to obtain large sums of money. Older homeowners who have spent years (if not decades) paying down their mortgage will also likely have a significant amount of money to play with, making now a great time to act.

Source: CBSNews.com

In my experience, the prevailing wisdom says that a HELOC is a great way to get your hands on cash in retirement. But is this correct?

In my opinion: no.

I think a HELOC is risky if you’re retired and living on a fixed income. I’ve come to this conclusion after many years of helping retirees with their mortgage lending needs. I’ll explain how a HELOC works, why the risks of a HELOC outweigh the benefits for retirees, then I’ll offer a less risky alternative.

What is a HELOC?

The HELOC is a popular home loan product that many homeowners use to borrow against their home equity on a revolving basis. In other words, like a credit card, you can borrow, repay, and reborrow again at your convenience.

HELOCs are attractive because the interest rates are reasonable, the closing costs are relatively cheap, and they’re easy to get if you have equity, decent income, and good credit.

They’re also attractive if you already have a mortgage with a low interest rate. A HELOC offers access to your home equity without having to refinance your existing mortgage.

HELOCs are convenient, but they’re not designed to be a long-term financing solution. HELOCs are best suited for borrowing and repaying on a short-term basis. This is why I think they’re risky for retirees living on a fixed income.

The Top 5 HELOC Risks

Now that we’ve covered some basics, let’s cover the top 5 HELOC risks for retired homeowners.

1) Interest-Only Payments

HELOCs typically have low minimum payments that cover just the interest. You have to make extra payments to actually pay down the debt.

In my experience, most seniors with HELOCs make just the minimum payments. The balance almost never goes down. In fact, the balance usually goes up as the homeowner continues to borrow to supplement income or pay for unexpected expenses.

2) Adjustable Interest Rates

Most HELOCs have adjustable interest rates based on the prime rate. If the prime rate increases, the payment will increase as well.

Many seniors with HELOCs discovered this the hard way as the COVID pandemic wound down. Inflation took off, so the Federal Reserve began increasing interest rates. The prime rate skyrocketed from 3.25% in early 2022 to 8.25% by the end of 2023. Ouch!

3) Full Recourse Repayment

If home values fall and you owe more than your home is worth, you’ll be on the hook for the shortage if you try to sell your home. You will either have to come up with a lot of cash or negotiate a short sale.

If you negotiate a short sale, you may have to pay income taxes on the forgiven loan amount.

4) Chopped, Revoked, or Taken Away

You can’t rely on your HELOC to always be there when you need it. If your bank gets worried about the economy or home values, they may chop, revoke, or freeze your available credit line with little notice.

It doesn’t matter if you have excellent credit, tons of home equity, or you’ve been with your bank for 40 years. If the bank sees risk, they’ll take steps to reduce it by eliminating outstanding credit lines.

This happened to many homeowners in 2021 when Wells Fargo closed all of their personal lines of credit. Again, you can’t rely on your HELOC to always be there when you need it.

5) The Recast

Of all the HELOC loan risks, this one is the worst, in my opinion. Let me explain how the recast works and why it’s a big risk for homeowners on a fixed income.

Most HELOCs allow you to withdraw funds for up to the first ten years of the loan. This is called the draw period.

At the end of the draw period, the bank recasts (or recalculates) the loan payment into a full principal and interest payment that pays back the entire outstanding balance over the remaining loan term.

HELOCs usually have a 20- or 25-year total loan term, which means the remaining loan term at the end of the 10-year draw period is usually around 10 to 15 years. When the bank recasts the payment, they’re essentially giving you a fully-amortized 10- or 15-year loan, which means you end up with a big monthly payment.

To see how devastating this can be – especially in a rising rate environment – let’s check out an example:

Let’s assume we have a retired homeowner named Phyllis who opened a 25-year $50,000 HELOC back in 2014. Phyllis didn’t use the HELOC until late 2021, when she borrowed the full $50,000 to do home renovations.

In late 2021, HELOC rates were super cheap. Her interest rate was around 4%, which meant her interest-only payment was just $167/month. For Phyllis, using her HELOC was a fantastic deal. She was able to redo her kitchen and two bathrooms for a mere $167/month.

Unfortunately for Phyllis, inflation took off after the pandemic, so the Federal Reserve began increasing interest rates. By late 2023, her interest rate hit 9.25%, which meant her interest-only payment more than doubled to $385/month.

Even worse, Phyllis reached the end of the draw period in 2024. Her bank recalculated her payment so she would repay the entire $50,000 balance over the remaining 15 years of the loan term. The recast caused her payment to jump to a whopping $514/month. Ouch!

Phyllis’ payment tripled in just three years because of rate increases and the recast. If Phyllis can’t afford her new payment and falls behind, she could face foreclosure.

Folks, as you can see, the recast can result in potentially devastating payment increases. And if you can’t afford your new payment, you could potentially lose your home.

The HELOC is a good loan product, but the risks of a HELOC outweigh the benefits for retired homeowners, in my opinion. HELOC risks include interest-only payments, adjustable rates, and the recast at the end of the draw period. All of these HELOC risks can result in a significantly higher payment in the future.

Current HELOC Rates

Still prefer a HELOC? If so, check out the table below for the latest HELOC rates.

Again, the point here is not to bash HELOCs. A HELOC is a great mortgage product for the right situation. If it’s right for you, then great! Check out below for the latest HELOC rates.

A Home Equity Line of Credit Alternative

In my opinion, the risks of a HELOC outweigh the potential benefits for retirement homeowners. A much safer solution is the FHA-insured HECM, or home equity conversion mortgage. The HECM is safer because it’s actually designed to be a reliable cash source in retirement.

The HECM is a type of reverse mortgage that enables homeowners 62 and older to convert a portion of the value of their home into cash without having to give up ownership of the home or take on a mortgage payment.

As long as at least one borrower (or non-borrowing spouse) lives in the home and pays the required property charges, no mortgage payments are required and the loan doesn’t have to be paid back.

The proceeds from a HECM reverse mortgage can be received in several ways, including lump sum, term or tenure income, line of credit, or some combination of these options.

The line of credit is an ideal substitute for a HELOC for several reasons:

  1. No monthly payments. Again, no payback is required as long as you remain in good standing. There is no payment risk if you borrow more or interest rates increase.
  2. You can count on the money being there. The line of credit cannot be chopped, revoked, or frozen as long as you meet your program obligations. Because the HECM is insured by FHA, you won’t lose your credit line even if your lender goes bankrupt. Even better, your available credit will grow and compound larger, which gives you access to more money automatically over time.
  3. Non-recourse. The most that will ever be paid back is the value of your home, even if it’s not worth enough to settle the entire balance.
  4. No recast. Again, no payments are required as long as you meet your program obligations.
  5. Less stringent credit requirements. HECMs are often much easier to qualify for than HELOCs. You don’t need to have stellar credit to qualify.

If your goal is leverage home equity to increase your financial security in retirement, I recommend the HECM over a HELOC.

Again, the risks of a HELOC outweigh the potential benefits, in my opinion. A HECM offers access to home equity without HELOC risks such as interest-only payments, adjustable rates, and the recast at the end of the draw period.

As long as you remain in good standing, you can rely on the HECM to be there when you need it.

Frequently Asked Questions

Is there a downside to having a HELOC?

The HELOC is a good loan product, but there are some HELOC loan risks you need to be aware of. HELOCs usually have interest-only payments, adjustable rates, and the recast at the end of the draw period can significantly increase your monthly payment.

Is a HELOC high risk?

If used correctly, a HELOC can be a convenient way to access home equity. However, there are some HELOC loan risks you need to be aware of. HELOCs usually have interest-only payments, adjustable rates, and the recast at the end of the draw period can significantly increase your monthly payment.

What happens to HELOC if market crashes?

If the real estate market crashes, your HELOC lender will likely freeze your available credit. If the market crashes enough and you owe more than your home is worth, you may be on the hook for the shortage. HELOCs are usually full recourse loans, which means you’ll have to settle the shortage out of pocket if you sell your home and it isn’t worth enough to pay off the entire balance.

How can a HELOC hurt you?

The HELOC offers convenient access to home equity, but there are some HELOC loan risks that can hurt you. HELOC risks include interest-only payments and adjustable rates. If rates increase, your payment could increase as well. At the end of the draw period, your lender will recalculate your payment so that you pay off the balance in full over the remaining loan term. This can significantly increase your payment as well.

What are the top risks of a HELOC?

The HELOC offers convenient access to home equity, but there are some HELOC loan risks that can hurt you. The top HELOC risks include interest-only payments and adjustable rates. If rates increase, your payment could increase as well. At the end of the draw period (usually the first ten years), your lender will recalculate your payment so that you pay off the balance in full over the remaining loan term. This can cause your payment to increase significantly as well.

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About Mike Roberts

Mike Roberts is the founder of MyHECM.com, an author, and a highly experienced veteran of the mortgage industry. When he's not working, he enjoys spending time with his family, skiing, camping, traveling, or reading a good book. Roberts is the author of The Reverse Mortgage Revealed: An Industry Insider’s Guide to the Reverse Mortgage, which is available on Amazon.

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