Many retirees think they can’t take out a loan because they no longer receive a salary. In fact, while it can be harder to qualify to borrow in retirement, it is far from impossible.
One thing you should generally avoid, according to most experts, is borrowing from your retirement plan, such as a 401(k), an IRA or a pension. That’s because doing so may adversely affect your savings and the income you count on in retirement. Instead, consider these 10 other options available to retirees. (For more, see Should You Borrow From Your Retirement Plan?)
Qualifying to Borrow in Retirement
If you are self-funded (earn most of your income from investments, rental property or retirement savings), lenders typically determine your monthly income using one of two methods:
- Drawdown on Assets – This method counts your regular monthly withdrawals from your retirement accounts as income.
- Asset Depletion – With this method the lender subtracts any down payment from the total value of your financial assets, takes 70% of the remainder and divides it by 360 months.
To either method the lender adds any pension income, Social Security benefits, annuity income and part-time employment income.
Secured vs. Unsecured Loans
When you borrow, the loan will either be secured or unsecured. A secured loan requires you to put up collateral, such as your home, investments, vehicles or other property, to guarantee it. If you fail to pay, the lender can seize the collateral. An unsecured loan, which does not require collateral, is more difficult to obtain and has a higher interest rate than a secured loan.
1. Mortgage Loan
The most common type of secured loan is a mortgage loan, which uses the home you are buying as collateral. The biggest issue with a mortgage loan for retirees is income, especially if most of yours comes from investments or savings.
2. Home-Equity Loan
This secured loan is based on borrowing against the equity in your home. You must have enough equity to retain 20% of it after taking out the loan. The new tax law no longer allows the deduction of interest on home equity loans unless you are using the money for home renovations. (For more, see Home-Equity Loans: What You Need to Know.)
3. Cash-Out Refinance Loan
This alternative to a home-equity loan involves refinancing your existing home for more than you owe but less than the home’s value. The extra amount becomes a secured cash loan. Unless you refinance for a shorter term, say 15 years, you will extend the time it takes to pay off your mortgage. To decide between refinance and home equity, consider interest rates on the old and new loan and closing costs.
4. Reverse Mortgage Loan
A reverse mortgage loan provides regular income or a lump sum based on the value of your home. Unlike a home-equity loan or refinance, the loan is not paid back until you die or move out of the home. (For more, see The Reverse Mortgage: A Retirement Tool.)
5. USDA Housing Repair Loan (Section 504)
If you meet the low-income threshold and need money for home repairs, you may qualify for a Section 504 loan through the U.S. Department of Agriculture. The interest rate is only 1% and you have 20 years to pay the loan back. The maximum loan amount is $20,000, with a potential additional $7,500 grant. For more information, go here.
6. Car Loan
A car loan offers competitive rates, and is easier to obtain, because it is secured by the vehicle you are buying. Paying with cash could save interest, but it only makes sense if it doesn’t deplete your savings. That’s because in the event of an emergency, you would have to sell the car to recover the funds.
7. Debt Consolidation Loan
A debt consolidation loan is designed to do just that – consolidate debt. In effect, an unsecured debt consolidation loan is a refinance of your existing debt. Generally, this may mean you will be paying this debt off longer, especially if payments are lower. In addition, the interest rate may or may not be lower than what you are paying now.
8. Student Loan Modification or Consolidation
Failure to pay student loan debt can result in Social Security payments being partially withheld. Fortunately, student loan modification and consolidation programs can reduce payments through deferment or even forbearance. To learn more, go here.
9. Unsecured Loans and Lines of Credit
While they are harder to get, unsecured loans and lines of credit don’t put assets at risk. Options include banks, credit unions, peer-to-peer loans (funded by investors) or even a credit card with a 0% annual percentage rate. Only consider the credit card as a source of funds if you know you can pay it off before the low rate expires.
10. Payday Loan
Almost anyone, including retirees, can qualify for a secured or unsecured short-term loan. The payday retirees enjoy is a monthly Social Security check and that's what you would be borrowing against. These loans have very high interest rates and fees. You should only consider a payday or short-term loan in an emergency and when you know you have money coming in to pay it off on time. Some experts say that even borrowing against your 401(k) is better than enmeshing yourself in one of these loans. If you can't repay it, the funds will roll over and the interest you owe will rapidly mushroom. (See Payday Loans Don't Pay.)
The Bottom Line
Borrowing money in retirement is less difficult than it used to be. Lenders are learning how to treat your assets as income. They're making more options available to those no longer in the workforce. Before taking money out of retirement savings, consider the alternatives offered here to keep your nest egg intact, better serving you for the long haul.