Many retirees think they can’t take out a loan—for a car, a home, or an emergency—because they no longer receive a salary. In fact, while it can be harder to qualify to borrow in retirement, it's far from impossible. One thing generally to avoid, according to most experts, is borrowing from retirement plans—such as 401(k)s, individual retirement accounts (IRAs), or pensions—as doing so may adversely affect both your savings and the income you count on in retirement.
- It's generally better to get some kind of loan than borrow from your retirement savings.
- Secured loans, which require collateral, are available to retirees and include mortgages, home equity and cash-out loans, reverse mortgages, and car loans.
- Borrowers can usually consolidate federal student loan debt; it's also possible to consolidate credit card debt.
- Almost anyone, including retirees, can qualify for a secured or unsecured short-term loan, but these are risky and should be considered only in an emergency.
Qualifying for Loans in Retirement
For self-funded retirees, earning most of their income from investments, rental property, or retirement savings, lenders typically determine a potential borrower's monthly income using one of two methods:
- Drawdown on assets counts regular monthly withdrawals from retirement accounts as income.
- Asset depletion, by which 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.
Keep in mind that loans are either secured or unsecured. A secured loan requires the borrower to put up collateral, such as a home, investments, vehicles, or other property, to guarantee the loan. If the borrower fails 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.
Here are 10 borrowing options—as well as their pluses and minuses—that retirees can use instead of taking funds from their nest egg.
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 it comes from investments or savings.
2. Home Equity Loan or HELOCs
This type of secured loan is based on borrowing against the equity in a home. A borrower must have 15% to 20% equity in their home—a loan-to-value (LTV) ratio of 80% to 85%—and generally a credit score of at least 620.
Notably, the Tax Cuts and Jobs Act no longer allows the deduction of interest on home equity loans unless the money is used for home renovations. Another option, similar to a home equity loan, is a home equity line of credit (HELOC).
Both are secured by the homeowners' home. A home equity loan is a loan that gives the borrower an upfront lump sum that is paid back over a set period of time with a fixed interest rate and payment amount. A HELOC, on the other hand, is a credit line that can be used as needed. HELOCs usually have variable interest rates and the payments generally are not fixed.
3. Cash-Out Refinance Loan
This alternative to a home equity loan involves refinancing an existing home for more than the borrower owes but less than the home’s value; the extra amount becomes a secured cash loan.
Unless refinancing for a shorter term—say, 15 years—the borrower will extend the time it takes to pay off the mortgage. To decide between refinancing and a home equity loan, consider interest rates on the old and new loan, as well as closing costs.
4. Reverse Mortgage Loan
A reverse mortgage loan (also known as a HECM—home equity conversion mortgage) provides regular income or a lump sum based on the value of a home. Unlike a home equity loan or refinancing, the loan is not paid back until the homeowner dies or moves out of the home.
At that point, generally, the homeowner or the heirs can sell the home to pay off the loan, the homeowner or heirs can refinance the loan to keep the home, or the lender may be authorized to sell the home to settle the loan balance.
Reverse mortgages can be predatory, targeting older adults who are desperate for cash. If your heirs do not have the funds to pay off the loan, that inheritance is lost.
5. USDA Housing Repair Loan
If you meet the low-income threshold and plan to use the 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 the repayment period is 20 years. The maximum loan amount is $20,000, with a potential additional $7,500 grant for older, very-low-income homeowners if it's used to remove health and safety hazards in the home.
To qualify, the borrower must be the homeowner and occupy the house, be unable to obtain affordable credit elsewhere, have a family income that is less than 50% of the area median income, and for grants, be 62 or older and unable to repay a repair loan.
While it can be harder to qualify to borrow in retirement, it's far from impossible.
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 only makes sense if it doesn’t deplete your savings. But in the event of an emergency, you can sell the car to recover the funds.
7. Debt Consolidation Loan
A debt consolidation loan is designed to do just that: consolidate debt. This type of unsecured loan refinances your existing debt. Generally, this may mean you will be paying off the debt longer, especially if payments are lower. In addition, the interest rate may or may not be lower than the rate on your current debt.
8. Student Loan Modification or Consolidation
Many older borrowers who have student loans don't realize that failure to pay this debt can result in their Social Security payments being partially withheld. Fortunately, student loan consolidation programs can simplify or reduce payments through deferment or even forbearance.
Most federal student loans are eligible for consolidation. However, Direct PLUS Loans to parents to help pay for a dependent student’s education cannot be consolidated with federal student loans that the student received.
9. Unsecured Loans and Lines of Credit
While harder to get, unsecured loans and lines of credit don’t put assets at risk. Options include banks, credit unions, peer-to-peer loans (P2P) (funded by investors), or even a credit card with a 0% introductory annual percentage rate. Only consider the credit card as a source of funds if you are certain 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 most retirees enjoy is a monthly Social Security check, and that's what's borrowed against. These loans have very high interest rates and fees and can be predatory.
You should only consider a payday or short-term loan in an emergency and when you're sure there's money coming in to pay it off on time. Some experts say that even borrowing against a 401(k) is better than becoming ensnared in one of these loans. If they're not repaid, the funds will roll over and the interest will rapidly mushroom.
The Bottom Line
Borrowing money in retirement is less difficult than it used to be and many alternative options for accessing cash are now available. For example, those people with whole life insurance policies might be able to get a loan by borrowing against their policy.
Additionally, lenders are learning how to treat borrowers' assets as income and are making more options available to those no longer in the workforce. Before taking money out of retirement savings, consider these alternatives to keep your nest egg intact.