BANKS make money primarily by charging interest on loans. Consumers should, however, pay careful attention to their loan portfolios. For the past two weeks I have highlighted the relevance of debt management, and this week the spotlight is on the pros and cons of home equity loans and how these types of loans impact homeowners, particularly retirees.

Asset allocation is a crucial step in creating wealth and financial freedom, a process that involves dividing assets into different groups such as real estate, stocks, and bonds. Real estate is a popular asset class for investors as owning a house is a priority for many employees and retirees. Some employees brag about their house becoming their pension, and at times pay little regard to the benefits of contributing to a pension plan. A house can be a valuable asset as it builds us equity or great value over time. But it can also lead to ruin if it’s not managed properly.

The equity in one’s home can be used as collateral for loans. Home equity is the difference between the market value of your property and what is owed on your mortgage. A home equity loan allows homeowners to use the equity in their house as collateral for a loan. The purposes of this loan range from home renovation to debt consolidation. But is this type of loan too risky? Should you use your home to pay debts? Individuals who seek to consolidate high-interest credit cards or clear large credit card balances may use a home equity loan to do so. It may also be used to cover children’s or grandchildren’s education. Emergency expenses and significant health-care costs are other reasons consumers access home equity loans. But these loans can also be used to purchase assets such as a second home or a commercial property. These options must be carefully assessed as it may not prove beneficial to get heavily in debt in pursuit of wealth.

Home equity loans often result in having a second mortgage on the same property, which can become quite distressing if debts balloon. It’s possible that a homeowner can be carrying up to three mortgages simultaneously. Those nearing retirement or retired and whose first mortgage is cleared or nearly paid off may find a home equity loan attractive in meeting certain financial responsibilities. Home equity loans offer lower interest rates than unsecured loans and also provide long repayment periods. However, there are pitfalls. You may lose your home if you are unable to repay the loans. If forced to sell the property, the home equity debt is a priority as the lender has to be paid from the proceeds of the sale.

Another risk that the homeowner faces is the propensity to spend since the borrower may have extra funds in hand that are not allotted for any particular purpose. Always remember that financial institutions offer home equity loans because they want to make money. This is the reason I recommend building an emergency fund early and also having long-term investments in diversified portfolios of assets. The older one gets, the less risk you should take as time is a luxurious asset. Avoid risking your home. Personal financial habits are necessary to safeguard your assets. You worked hard and your assets should work for you, especially in retirement. No one wants to outlive his or her money so careful financial planning is advisable.

If a substantial emergency fund is built up during the working years then retirees would be in a better position to meet huge, unexpected expenses or welcome a financial opportunity such as purchasing a second house or buying other property — instead of contending with increasing debt in retirement. As you near retirement one priority is to clear or reduce debt as much as possible. Home equity loans may be easily accessible but spending years in repaying interest only enriches the lender. Long repayment periods mean more interest being paid. Life is filled with uncertainties, and with the best intention of repaying debts the unexpected financial humps leave no room for the retiree who is on a fixed income, with inflation an imminent threat.

An alternative that homeowners have to a home equity loan is the refinancing of their mortgage at a lower interest rate. This may not be easy to obtain in a high-interest market environment but it pays to shop around. Mortgage refinancing means that the old mortgage is replaced by a new one with more favourable terms and conditions. Being debt-free provides peace of mind. It was author Publius Syrus who said: “Debt is the slavery of the free.” Remember those wise words.

Grace G McLean is a financial advisor and retirement specialist at BPM Financial Limited.
Contact her at: gmclean@bpmfinancial or visit the website: www.bpmfinancial.com
She is also a podcaster for Living Above Self.
E-mail her at livingaboveself@gmail.com