Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Can Use Home Equity as a Backup Plan
Transcript
- Lucas: You know that moment in early retirement planning where you've got your withdrawal rate all mapped out, your portfolio is balanced, and then the market drops thirty percent — and suddenly you're staring at your brokerage account thinking, I really don't want to sell right now? Luna: Oh, absolutely. That's the sequence of returns nightmare we've talked about before. But today you've got a different angle, right? Lucas: Yeah. Most people think about two options when the market's down: either sell at a loss or cut spending. But there's a third one that doesn't get nearly enough attention — using your home equity as a temporary buffer. Luna: A home equity line of credit? I feel like the FIRE community has mixed feelings about that. Some people treat it like an emergency fund, others say debt is debt, period. Lucas: Right. And I want to drill into a specific case that makes the trade-offs really concrete. I talked to a couple — let's call them Mark and Jen — who retired at 46. They'd done everything right. Four percent rule, low-cost index funds, paid-off house in the suburbs outside Portland. Then 2022 happened. Luna: The year bonds and stocks both fell. Brutal for anyone with a traditional sixty-forty portfolio. Lucas: Exactly. They needed about sixty thousand dollars a year to live on. Normally they'd sell from their taxable account. But by October 2022, that account was down twenty-five percent. Selling meant locking in losses and reducing their portfolio's ability to recover. So instead, they drew down their HELOC — they had a three hundred thousand dollar line at a variable rate, which was then around seven and a half percent. Luna: Seven and a half percent is expensive debt. How long did they carry it? Lucas: Eleven months. They borrowed about forty-five thousand total. Then in late 2023, when the market had recovered, they sold some appreciated shares — paying long-term capital gains rates — and paid off the HELOC in full. Net cost: about three thousand dollars in interest. Luna: Three thousand bucks to avoid selling at the bottom. That's a pretty cheap insurance premium. Lucas: Right. And the math gets even better if you think about what they would have lost by selling in 2022. If they'd sold forty-five thousand dollars of an S&P 500 fund when it was down twenty-five percent, they would have needed to sell about sixty thousand dollars' worth of shares to net forty-five after the loss. And they'd have permanently reduced their portfolio's base. That forty-five thousand they withdrew from the HELOC, by the way, later grew back to about fifty-five thousand in the market. So the opportunity cost of selling early was probably around ten thousand dollars — far more than the interest they paid. Luna: So the key is that it's temporary. They had a clear exit plan. That feels different from someone who treats a HELOC like a second checking account. Lucas: Totally. And that's the behavioral edge, too. When you know you have a cash cushion that doesn't require selling stocks, you're less likely to panic and make a permanent mistake. There's actually a 2024 study from the Journal of Retirement that looked at early retirees who had access to a HELOC during the 2020 crash. They were about forty percent less likely to sell equities during the downturn. Luna: Forty percent. That's significant. But let's talk about the risks, because a variable rate HELOC at, say, nine or ten percent could get ugly if you carry the balance too long. Lucas: Absolutely. The biggest risk is rate resets. In 2022, the average HELOC rate went from about four percent to over eight percent in eighteen months. If you borrow sixty thousand and the rate jumps to ten percent, that's six thousand a year in interest. If you're not disciplined about paying it off quickly, it can eat into your withdrawal rate significantly. Luna: And there's also the risk of serial refinancing — taking out a new HELOC to pay off the old one, or just never actually repaying it. That turns a tactical tool into a long-term drag. Lucas: Right. Mark and Jen had a rule: they would only use the HELOC during bear markets, and they would repay it within twelve to eighteen months of the market recovering. That kind of discipline is critical. Otherwise you're just leveraging your house to maintain a lifestyle, which is a whole different conversation. Luna: So for someone listening who's building their early retirement plan, what's the takeaway? Should they go get a HELOC tomorrow? Lucas: Not necessarily. First, you need to have a HELOC in place before you need it. Lenders can freeze or reduce lines during a crisis — that happened a lot in 2008 and even in 2020. So you want to open it when you're still employed and your credit is solid, even if you never plan to use it. Second, think about the size. Mark and Jen's three hundred thousand dollar line was about two years of expenses. That's probably enough to weather a typical bear market without selling. Luna: And what about the cost of setting it up? Some HELOCs have closing costs, annual fees, or require a minimum draw. Lucas: Good point. Many credit unions offer no-cost HELOCs with no annual fee. Shop around. You want one that's truly a standby tool — no cost to keep it open, no requirement to draw. Mark and Jen paid zero to set theirs up. The only cost was the variable interest if they used it. Luna: This episode has really made me rethink the role of home equity. I'd always thought of it as a last resort, but framed as a tactical buffer during downturns, it makes a lot of sense. Lucas: Yeah, and that's the kind of conversation we love having on this show — finding the nuance between the hard rules and the real-world flexibility. If our money conversations have helped you think about a decision differently, or if you've found a new angle on your own plan, that's exactly why we do this. Luna: And if you've gotten value from episodes like this one, the best way to keep them coming is through listener support. It's what keeps the show ad-free and focused on the details that actually matter. Lucas: Right. So if you're able, you can support the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. Every contribution goes straight into research, hosting, and keeping these conversations independent. Luna: And we really appreciate it. Now, Lucas, let's get back to the mechanics. You mentioned pledged asset lines earlier — how is that different from a HELOC? Lucas: Good question. A pledged asset line, or PAL, is a loan backed by your investment portfolio instead of your house. You typically get a lower rate than a HELOC — maybe five to six percent — because the collateral is liquid securities. But the risk is that if your portfolio drops, the bank can issue a margin call and you have to deposit more collateral or sell. During a severe crash, that's the last thing you want. Luna: So a HELOC is actually safer from that perspective because the value of your house is less volatile than stocks. Even in a housing downturn, it rarely drops fifty percent overnight. Lucas: Exactly. And that stability is what makes it a good buffer for sequence risk. Your home equity doesn't fluctuate with the market the way your portfolio does. So when stocks are down, your borrowing capacity is still there. That's the whole point. Luna: One more thing — taxes. The interest on a HELOC is only deductible if you use the money to buy, build, or substantially improve your home. Using it for living expenses is not deductible. That's a common misconception. Lucas: Great catch. So Mark and Jen's interest wasn't deductible. But even so, three thousand dollars in after-tax interest to avoid a permanent portfolio hit is still a win. The key is to run your own numbers. For someone with a million-dollar portfolio and a paid-off house, a sixty-thousand-dollar HELOC draw at eight percent for one year costs about forty-eight hundred dollars. Would you rather pay that or sell at a twenty-five percent loss? Most people would pay the interest. Luna: I think the behavioral side is actually the biggest benefit. Knowing you have that buffer lets you sleep at night during a crash. And that can prevent the worst mistake of all — panic selling and never getting back in. Lucas: Exactly. So if you're in early retirement or planning for it, consider having a HELOC in place before you need it. It's not for everyone — if you're debt-averse or have a variable income, maybe skip it. But for a disciplined retiree with a paid-off house and a clear plan, it's a powerful tool in the toolkit. Luna: Alright, next episode I want to talk about the reverse mortgage — which is basically the opposite end of the spectrum. But that's a whole different can of worms. Lucas: Perfect. We'll see you then.