Risks in Taking a Loan Against Your Retirement Account

As you get older you realize that your life hasn’t turned out exactly the way you thought it would. Luckily in most cases you have a happy life, filled with people you care about and a lot of good memories. However, when many people look back on their lives approaching retirement, they can find that their life is filled with too little money, and so look to take out a loan.

Not only is taking out a loan when you are at retirement age risky, it is also very difficult, and to help you make the decision on the best way to make sure your golden years are filled with enough gold, find out more about loans for retirees.

What is a loan at retirement?

At any age, your loan application and interest rate is determined based on your level of risk. However, as you get older, the risk for the lender increases that you will lose your full income before the end of the loan term. As a result, many lenders will provide only short loan terms to borrowers over 35 years old, to ensure their loan is repaid before retirement age.

Therefore, if you are over 50, your chances of being approved for a loan are even lower and you can be required to source additional documentation, and show proof of your ability to repay the loan if you sell the asset you are borrowing to buy.

How to apply for a loan in your retirement?

If you are already over 65 and are looking for more funds to finances your travel dreams or home renovation needs you can still apply for a loan. In most cases you will have income from shares, investment properties or a part time income and this can be enough to secure loan approval.

If you don’t have enough ongoing income to qualify for a loan, you can apply for a senior’s equity release, which is also known as a reverse mortgage. If you own your home you can borrow a portion of the equity, and no repayments are required as the interest capitalizes while you are alive, and when you die, the sale of your home repays your loan. With a senior’s equity release you don’t need to prove your income because you don’t need to make any repayments.

At the same time, each lender has their own requirements for lending to retirees and those approaching retirement, and you may be able to secure finance with a written exit strategy covering the sale of your own property if it is used as security for the loan. However, downsizing to a smaller home is not a satisfactory exit strategy for some lenders, so you may have to plan to sell shares or other investments or make lump sum repayments from your superannuation fund.

If you don’t provide an exit strategy, some lenders will make sure that the loan term doesn’t exceed your expected retirement age. While the accepted retirement age varies from 65 to 75, if you were 45 and taking out a home loan, the lender may set a loan term of 20 years so that the loan is repaid by the time you are 65.

Risks of Borrowing at Retirement

While the equity in your home may seem to be sitting there doing nothing there can be a number of risks associated with borrowing against your home, especially when you don’t have the means to earn a full income, and staying in your home is important to your lifestyle.

Before you borrow at retirement, consider the risks which include:

  • Compounding interest. Because no repayments are required, the interest on a reverse mortgage capitalises into the loan. However, this means that the interest charged on your loan compounds, calculating interest on the amount you have borrowed, plus the amount of the interest repayment due.
  • The longer you live, the greater your debt. The longer your repayments capitalise into your equity loan, the higher your loan amount will be, so you can be looking at a reverse mortgage which owes more than your property is worth, and your estate could make a loss from the sale when you die.
  • Variable interest rate. If the interest rate on your reverse mortgage is variable, the amount your loan increases can become significant over time as official interest rates rise.
  • The equity is gone. Once you have tapped into your home equity for a lump sum payment or to provide an income in your retirement, that money is gone, and if you then find you need funds to make the move to an aged care home, or for increased care needs the funds won’t be there.

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