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Dr. Don Taylor, CFA, Bankrate.com advice columnistFinancing home improvements in retirement

Dear Dr. Don,
I'm 64 and need $75,000 for home upgrades. I have $300,000 plus in home equity. Would it be best to refinance with an interest-only loan to keep payments down, and then possibly get a reverse mortgage or use IRA monies and pay the taxes on that distribution?
-- Larry Leverage

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Dear Larry,
Thanks for providing some additional information about your financial situation to me so I might better answer your question. You told me you are married, retired, have an annual income of about $45,000 per year and have excellent credit. You also told me that your home is worth about $550,000, and there is about $200,000 in outstanding mortgage debt on the home. You have about $150,000 in retirement accounts and no investments in taxable (nonretirement) accounts.

Lending limits on the two main reverse mortgage programs, HECM, or Home Equity Conversion Mortgage, and Fannie Mae Home Keeper, won't let you get a $275,000 reverse mortgage. That's because the first step in getting a reverse mortgage is to pay off any existing mortgages with the proceeds from the reverse mortgage. Put in your particulars using the reverse mortgage calculator at reversemortgage.org and you'll see the problem in black and white. Besides, it's an expensive way to tap the equity in your home, and I'd like to see you hold that option open for future use. A Bankrate feature, "Reverse mortgages: Retirement's on the house," explains reverse mortgages in greater depth.

I like the idea of using a home equity line of credit, or HELOC, even though, since it's a variable-rate loan, you are taking on the risk that short-term interest rates continue to head higher.

The two reasons why I like the HELOC are: The payments are interest-only in the early years of the loan, and closing costs are minimal. The downside is the national average interest rate on a HELOC is currently 8.21 percent.

A cash-out first mortgage can also make sense if the rate is competitive with the rate on your existing mortgage. The national average for a 30-year fixed-rate mortgage is currently 6.49 percent. Saving 1.72 percent versus the HELOC rate can justify paying the higher closing costs. Although it's not interest-only, the extended loan term on the $275,000 loan balance should make the payments affordable. Try the Mortgage Professor's cash out refinancing calculator to see which of these two options makes sense.

Since I can't give you tax advice, you should ask your accountant whether it makes sense to draw down money from your IRA now to reduce the loan needed for home improvements or to pay down the principal balance on the mortgage(s), or wait until you are required to take distributions in your early 70's. My guess is that it makes sense to wait, but you don't want to guesstimate this decision. For financial flexibility, if you can afford the monthly payments on the mortgage(s), it makes more sense to keep the IRA money invested.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: Sept. 11, 2006
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