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EarlyRetire Tip: Using a HELOC to Stretch Your Retirement Income

Published by Hamilton Software, Inc. on July 20, 2014 | Comments

A home equity line of credit can be extremely useful for stretching your income in retirement. For those unfamiliar, a home equity line of credit (HELOC) is a form of second mortgage which acts like a charge account. It doesn't become a loan until you borrow from it, and you can borrow from it whenever you need to in whatever amount you wish (up to the credit limit). Repayment terms are equally flexible, and interest rates are typically tied to the prevailing prime rate.

It's a good idea to have one, especially if you're planning an early retirement, because it provides a convenient way to borrow against your home equity as an emergency cash reserve. To get the best terms, you should set it up before you retire, because your employment status will affect the amount of credit and interest rate a lender will offer you. Normally you shouldn't plan to use it except for emergencies, but there are circumstances in which it can be part of a strategic plan to stretch income.

There can be instances when using your retirement assets to pay for living expenses over the course of one or two years is not ideal. For instance, suppose you would need to sell stock and pay a large capital gain, or take a huge loss because of a recent market decline. Or if you're under 59½, you may be faced with the decision to make an early withdrawal from an IRA and pay a 10% penalty or start a 72(t) plan. In such cases, it may be to your advantage to borrow from your HELOC to meet your needs for a temporary period, and pay the loan back using retirement assets in better years.

You can test the idea in EarlyRetire Pro using Financial Events.

Since HELOCs are borrow-as-you-need and pay-when-you-can loans, setting up a standard loan event in EarlyRetire may not be the best way to model such borrowing. Standard loans provide a single inflow of principal up front, and a schedule of regular repayments over a fixed term. There are a couple of better ways to model a HELOC.

You could set up two events, one with an annual inflow in your Generic category, representing the borrowing you expect to do, and another with a generic outflow starting later, representing your repayment. Of course that requires you to calculate the interest and determine when and how quickly you should pay off the loan.

If your taxable assets have run out, there's an easier way. You can create a single event in which the annual amount you expect to borrow is represented both as a negative value in the Taxable category, and a positive value in the Generic category. The event therefore represents a transfer from taxable assets to generic assets (which are used immediately to provide your Net Income). Since you have no taxable assets, a deficit will accrue in the Taxable category, accruing interest automatically. EarlyRetire will then pay back the deficit with your retirement assets in the most efficient way, according to the distribution algorithm parameters in effect.

Since you generally don't use your home as an asset to pay living expenses, making use of its equity in retirement is an essential tool for stretching your other assets further (note that reverse mortgages can be structured similarly to HELOCS and used the same way). There are always ways to model such creative ideas in EarlyRetire through imaginative use of the Optimization Settings and Financial Events. Be sure to submit any questions on how to best implement an idea, and our support staff will be happy to help you.

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