Periods of financial stress can set the stage for difficult decisions for retirees, particularly when markets are down at the same time cash is needed for living expenses or an unexpected cost. Having another source of funds available can help reduce the need to sell investments after a decline and give the portfolio more time to recover.
For homeowners, one of the most obvious places to look is home equity. A home equity line of credit, or HELOC, can seem like a natural fit because it provides flexible access to cash without requiring the homeowner to sell investments or maintain a large reserve. It is easy to think of the line as a financial backup plan to tap when other assets are under pressure.
A wrinkle in this plan is that a HELOC does not guarantee access to that equity under all circumstances. Depending on the loan terms and changes in the borrower’s financial situation or the home’s value, the lender may be able to reduce or suspend access to the line. Those restrictions can become especially important during periods of broader financial stress, which may be precisely when a retiree intended to rely on the HELOC.
For someone who wants to incorporate home equity into a retirement income strategy, the structure of the borrowing arrangement is important. A Home Equity Conversion Mortgage, or HECM, line of credit works differently from a traditional HELOC and may provide a more reliable source of home equity when the goal is to use it as a retirement buffer asset.
The Role of a Retirement Buffer Asset
Sequence-of-returns risk is one reason investing in retirement differs from saving for retirement. A market decline early in retirement can be especially damaging when it occurs at the same time withdrawals are being taken from the portfolio.
For example, suppose a retiree needs $80,000 from investments during a year when the stock market has fallen substantially. Taking that withdrawal means selling more shares at lower prices, leaving fewer shares in the portfolio to participate in a future recovery. If poor returns continue while withdrawals are still being taken, the effect can compound over time.
A buffer asset provides the retiree with another source of funds to draw on temporarily. Instead of selling investments during a market downturn, they might use cash reserves, certain insurance assets, or home equity, giving the portfolio more time to recover.
Home equity can therefore become part of the retirement income strategy when the goal is to reduce the need to sell investments at unfavorable times. If that is the role home equity is expected to play, the reliability of access matters just as much as the amount of equity available.
How a HELOC Works
A HELOC allows a homeowner to borrow against home equity during a specified draw period. The homeowner can borrow, repay the balance, and borrow again up to the available limit, much like a revolving line of credit. Because borrowers generally pay interest only on the funds they have drawn, a HELOC can be an appealing way to maintain access to home equity without taking out a large lump-sum loan.
The limitation is that the available credit is not guaranteed to remain unchanged. Federal rules allow lenders to reduce or suspend access to a HELOC under certain circumstances, including a significant decline in the home’s value or a material change in the borrower’s financial circumstances that gives the lender reasonable grounds to believe repayment may become more difficult. The Consumer Financial Protection Bureau (CFPB) notes that such changes can affect a homeowner’s ability to continue borrowing against an existing line of credit.
From the lender’s perspective, that makes sense. The amount a lender is willing to make available depends in part on the home’s value and the borrower’s ability to repay. If either changes materially, the lender may reconsider how much additional credit it is willing to provide.
From the retiree’s perspective, the concern is different. If the HELOC is being counted on as a source of cash during a market downturn, the possibility that access could change as financial conditions deteriorate becomes more important.
Why Access Can Become More Important During Periods of Financial Stress
Periods of economic stress can also bring falling home values, tighter lending standards, job losses, and declining income. That means a retiree may want to rely on home equity even as lenders become more cautious about extending additional credit.
The financial crisis provides a useful example of this in practice. HELOC reductions and freezes became common enough that the Federal Reserve issued consumer guidance in 2009 explaining what homeowners could do when access to their lines was restricted. The guidance noted that lenders could reduce or suspend additional borrowing even when payments were current if, among other reasons, the home’s value had declined significantly.
This does not mean a HELOC will automatically be frozen during every recession or market decline. The example illustrates why an unused credit line should not be treated the same as cash already sitting in a bank account. A homeowner may have a $200,000 line available under normal conditions, but there is no guarantee that the full amount will remain available under all circumstances.
If the HELOC is intended for a specific purpose, such as a renovation, a large purchase, or occasional short-term liquidity, the lower cost and flexibility of a HELOC may be more important than certainty of access during an extreme market environment. A retirement buffer asset provides an additional source of funds when selling investments would be especially costly.
How a HECM Line of Credit Differs
A Home Equity Conversion Mortgage, or HECM, is the federally insured form of reverse mortgage available to eligible homeowners age 62 and older. It can be structured as a line of credit, but it operates differently from a traditional HELOC.
For readers who want to see how these loans work in more detail, our Understanding Reverse Mortgages workshop walks through eligibility, costs, and how the line of credit feature works in practice.
With a HECM, borrowers are not required to make monthly principal and interest payments while they remain in the home and continue to meet the loan requirements, including paying property taxes and homeowners insurance and maintaining the property. Interest and other charges are added to the loan balance over time, and the balance is generally repaid when the home is sold, the borrower permanently leaves the home, or the last borrower dies.
A HECM line of credit also has a feature that can be particularly useful in long-term planning. Unused borrowing capacity can increase over time. This is not investment growth, and the homeowner is not earning interest on unused funds. Instead, the amount available to borrow in the future increases according to the terms of the HECM.
For retirement planning purposes, what matters most is whether the line remains available when financial conditions deteriorate. Unlike a traditional HELOC, a HECM line is not subject to the same kind of reduction simply because home values fall or broader credit conditions tighten. As long as the borrower continues to meet the loan requirements, the available line is generally designed to remain in place.
That added reliability can make a HECM more relevant when home equity is used as part of a retirement income strategy. If the goal is to have another source of funds available during a market downturn, the ability to rely on that borrowing capacity can weigh more heavily than just choosing the option with the lowest initial cost.
The Lower-Cost Option Is Not Always the Better Fit
The additional reliability of a HECM comes at a cost. HECMs are generally more expensive to establish than HELOCs and can include origination fees, appraisal and closing costs, mortgage insurance, and interest that accumulates on amounts borrowed. If someone only wants inexpensive access to home equity for a renovation, expects to borrow for a relatively short period, or plans to repay the balance quickly, a HELOC may be the more sensible choice.
A HECM is better evaluated as part of the overall retirement income plan rather than as a standalone borrowing product. Those higher costs may not make sense if the line is unlikely to play a meaningful role in the retirement strategy. The potential value comes from having another source of funds available when selling investments may be especially costly to the long-term plan. That is why a HECM should be assessed alongside the household’s other resources rather than judged mainly by its upfront cost.
Whether a HECM makes sense depends on factors such as the homeowner’s age, home value, existing mortgage balance, portfolio size, spending needs, expected time in the home, and legacy goals. Comparing a HECM and a HELOC only on fees misses an important part of what each is designed to accomplish.
Choosing the Tool Based on the Job
A HELOC can be a useful financial planning tool for homeowners who want relatively low-cost access to equity, expect to repay borrowed amounts quickly, or simply want a flexible source of funds for occasional expenses. A retiree who already has substantial cash reserves and does not expect to rely on home equity during a market downturn may have little reason to incur the additional costs of establishing a HECM.
The stakes are higher when a HELOC is expected to do more than provide flexible access to credit. If the retirement strategy assumes that home equity will be available during a future market decline, the possibility that the lender may reduce or suspend access must be part of the analysis.
A HECM may be more appropriate when home equity represents a meaningful part of household wealth and the retiree wants to incorporate it directly into the retirement income plan. For example, someone who normally takes portfolio withdrawals could temporarily draw from a HECM during a significant market decline and resume withdrawals after markets recover. In that setting, the HECM becomes another resource on the household balance sheet that can be coordinated with investments and other sources of retirement income.
This does not mean homeowners should replace a HELOC with a reverse mortgage simply because they want access to cash. The two tools are designed to solve different problems. A HELOC can be an efficient and flexible way to borrow against home equity, while a HECM may be better suited to a retirement strategy in which reliable future access to that equity is part of the plan.
For retirees who want to use home equity as a buffer against sequence-of-returns risk, the comparison involves more than cost alone. It also requires considering whether the funds are likely to remain available under the conditions in which the retirement plan expects to use them.
Want to learn more? Listen to Episode 246 of the Retire With Style Podcast.
