Author Topic: Home equity line of credit - Strategy  (Read 7577 times)

dabears847

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Home equity line of credit - Strategy
« on: March 02, 2016, 09:17:19 AM »
Hello,

I'm hoping you can help with a few questions or ideas. My house is almost paid off, just a few more months to go and I'd like to use or consider the homes equity as part of my early retirement strategy. I'm considering getting an equity line up to 80% ltv for a down market in early retirement.

1. Floor and Ceiling withdrawal, check
2. Home Equity draw on down market years or a portion
? Draw year one of down market
? Draw after a few down years
? Don't draw at all too risky?

2b. Market return - pay down equity line to zero balance.

3. Once our kids graduate college, downsize the house.
4. Yes we have Social Security that will cover most of our expenses.


GrowingTheGreen

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Re: Home equity line of credit - Strategy
« Reply #1 on: March 02, 2016, 01:59:28 PM »
If I understand correctly, you're doing this as a contingency in case your investment accounts do not provide enough income for you to live off of?

If so, perhaps reevaluate your situation. Are you truly ready to retire? Have you analyzed your asset allocation to minimize the impacts of a "down" market?

If it's a truly terrible market and house prices drop, your bank can freeze your HELOC. They can also freeze it if your credit changes or they believe you won't be able to make payments.

Dicey

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Re: Home equity line of credit - Strategy
« Reply #2 on: March 03, 2016, 12:50:31 AM »
Um, since a heloc can be much more costly than a first mortgage, why not get a cheap, fixed mortgage for as much as you can comfortably afford and focus on saving and investing so you'll have enough to live on to retirement and beyond?

dabears847

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Re: Home equity line of credit - Strategy
« Reply #3 on: March 03, 2016, 04:29:19 PM »
I'm thinking of using it more as a vehicle if the portfolio takes a huge dip like in 2008. I'm creating my plan for how to handle a down market from 1 year to many years. I'm using a 4% strategy and will be ready in 1-2 years. I will only draw equity if needed so the balance will hopefully be zero.

Market Dip
Spending Range Floor and Ceiling
Portfolio Drop from 1-24% do nothing, spend like normal
 or Floor will kick in as portfolio drops 4% withdrawal
I like Dr. Doom's 25% portfolio drop kicks in reduction in spending - floor
40% market Drop, Draw from Heloc to help cover expenses
...50/50 half withdrawals from home equity and other half from stocks
60% Market Drop: Part Time Income, Home Equity, Stock withdrawal

Another Reader

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Re: Home equity line of credit - Strategy
« Reply #4 on: March 03, 2016, 04:39:11 PM »
When the stock market dropped in 2008, home values were plummeting as well.  Lots of folks had their equity lines suspended or canceled as banks protected themselves from potential losses.  I would not rely on a HELOC for living expenses in another 2008-2012 style housing market crash. 

Telecaster

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Re: Home equity line of credit - Strategy
« Reply #5 on: March 03, 2016, 04:48:41 PM »
Terrible idea. 

dabears847

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Re: Home equity line of credit - Strategy
« Reply #6 on: March 03, 2016, 08:04:46 PM »
Terrible idea.

Well, that's why I ask. If the house is paid off and I have to cover a down market for five years, I've got plenty of equity to carry the downfall for many years.

$360,000 Paid off house
$0 balance home equity and no 1st mortgage
I can cover 10 years of a down market before I touch my portfolio
floor $30,000

Another Reader

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Re: Home equity line of credit - Strategy
« Reply #7 on: March 04, 2016, 04:17:48 AM »
If the market drops for an extended period, it's likely that the economy is in bad shape and the value of your home has also gone down.  Banks will reduce or close HELOCs to avoid the risk of loss.  Or they might consider YOU risky and cut off both the HELOC and your credit cards.  This has happened before and it will happen again.  Lack of liquidity at just the wrong tome will force you to sell your income producing assets at low prices.  A cash (liquidity) reserve will carry you through.

ETA:  Those of us with cash on hand will be buying all your assets on sale.  Wouldn't you rather be the buyer than the seller in that situation?
« Last Edit: March 04, 2016, 04:24:32 AM by Another Reader »

El Marinero

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Re: Home equity line of credit - Strategy
« Reply #8 on: March 04, 2016, 11:15:00 AM »
When the stock market dropped in 2008, home values were plummeting as well.  Lots of folks had their equity lines suspended or canceled as banks protected themselves from potential losses.

This happened to me in 2008 with an unused equity line, while there was still plenty of equity.  The closure had much more to do with the bank's balance sheet than it did with mine.

I think an equity line of credit is cheap insurance against needing cash quickly, but I don't plan to use it to market-time  my portfolio.  'Cuz isn't that what is being suggested here?

Telecaster

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Re: Home equity line of credit - Strategy
« Reply #9 on: March 04, 2016, 11:43:48 AM »
Terrible idea.

Well, that's why I ask. If the house is paid off and I have to cover a down market for five years, I've got plenty of equity to carry the downfall for many years.

$360,000 Paid off house
$0 balance home equity and no 1st mortgage
I can cover 10 years of a down market before I touch my portfolio
floor $30,000

Here's why I said it was terrible:  You are trying to do two things, 1) protect yourself from market volatility, and 2) put some of that unused equity in your house to work for you. 

But 4% "rule" says you don't need to worry about market volatility.  So the goal should be to retire with sufficient assets.     The problem with using the HELOC in the manner you describe is that HELOCs are typically variable interest, so what if interest rates are high when the market is down?   If your HELOC is at say 6% (not an unreasonable number at all), that means you are essentially borrowing like mad from your future assets in your to eventually pay the HELOC off.    In other words, it very well could cost you a huge amount of money to protect yourself from volatility. 

And as Another Reader points out, the HELOC is granted at the whim of the bank.   And banks don't like to loan money to people without incomes.  What if you decide you need to tap the HELOC and they decide they don't you want you to?  Kinda blows a hole in your strategy.   Oh, and banks like to see income when they make loans.   Makes shopping for HELOCs problematic if you are retired.

But let me through out a possible solution:  Do a cash-out refi on your current house for as much as you can, invest it all, and get a nice long 30-year mortgage.   In the innumerable "should I pay off the house" threads,  people have shown this is actually a really great strategy.   It puts your equity to work right now, and keeps it working for a long time.       








themagicman

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Re: Home equity line of credit - Strategy
« Reply #10 on: March 04, 2016, 12:55:47 PM »

But let me through out a possible solution:  Do a cash-out refi on your current house for as much as you can, invest it all, and get a nice long 30-year mortgage.   In the innumerable "should I pay off the house" threads,  people have shown this is actually a really great strategy.   It puts your equity to work right now, and keeps it working for a long time.     

I have been looking to do this. I have a lot of equity in my home that I am wanting to take out and invest. Problem is I do not think it is worth the 4-5k of closing costs. Is there any way around this? Any one use any low or no closing cost refinance options?

dabears847

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Re: Home equity line of credit - Strategy
« Reply #11 on: March 08, 2016, 12:45:08 PM »
Terrible idea.

Well, that's why I ask. If the house is paid off and I have to cover a down market for five years, I've got plenty of equity to carry the downfall for many years.

$360,000 Paid off house
$0 balance home equity and no 1st mortgage
I can cover 10 years of a down market before I touch my portfolio
floor $30,000

Here's why I said it was terrible:  You are trying to do two things, 1) protect yourself from market volatility, and 2) put some of that unused equity in your house to work for you. 

But 4% "rule" says you don't need to worry about market volatility.  So the goal should be to retire with sufficient assets.     The problem with using the HELOC in the manner you describe is that HELOCs are typically variable interest, so what if interest rates are high when the market is down?   If your HELOC is at say 6% (not an unreasonable number at all), that means you are essentially borrowing like mad from your future assets in your to eventually pay the HELOC off.    In other words, it very well could cost you a huge amount of money to protect yourself from volatility. 

And as Another Reader points out, the HELOC is granted at the whim of the bank.   And banks don't like to loan money to people without incomes.  What if you decide you need to tap the HELOC and they decide they don't you want you to?  Kinda blows a hole in your strategy.   Oh, and banks like to see income when they make loans.   Makes shopping for HELOCs problematic if you are retired.

But let me through out a possible solution:  Do a cash-out refi on your current house for as much as you can, invest it all, and get a nice long 30-year mortgage.   In the innumerable "should I pay off the house" threads,  people have shown this is actually a really great strategy.   It puts your equity to work right now, and keeps it working for a long time.     

I'll throw out a few different scenarios. First I'll obtain a 15 year 80% loan to value, loan before a quit my job at the bank... I'm a banker. I held three home equity loans during the house crash and managed them accordingly. Not worried about having nothing, worst case is a reduced amount to reflect the lower value.

Goal: To help pad the portfolio in the first 10-15 years when it is most volatile. Also, from other posters, the first two years of a market drop is the worst of most market downturns and then the portfolio would come around... Is this accurate? This allows somewhat best of both worlds, mortgage without mortgage and deploy assets as needed.

Questions: If you would cash out a house and invest today, why not do it when the market is tanking? My home equity loan will have 3 active locking options currently in the 4% range with a 30 year amortization. Otherwise, if all is well then no mortgage expense is going to occur cash out 1st or 2nd.

What does the typical market tanking look like? For small movements, I would do nothing, keep the course.

Plan:
1 year cash to cover expenses and heloc as backup
Year 2 market down 40%, no cash, rebalance book, and pull floor from Home Equity for $30,000
Year 3a. Market should come back in most scenarios, payoff home equity
or
Year 3b. Market still down 40% pull from home equity loan $30,000, now starting to get concerned, when will portfolio come back... Deploy: Side income, spending floor, home equity usage.






Telecaster

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Re: Home equity line of credit - Strategy
« Reply #12 on: March 08, 2016, 06:01:47 PM »


What does the typical market tanking look like? For small movements, I would do nothing, keep the course.

Plan:
1 year cash to cover expenses and heloc as backup
Year 2 market down 40%, no cash, rebalance book, and pull floor from Home Equity for $30,000
Year 3a. Market should come back in most scenarios, payoff home equity
or
Year 3b. Market still down 40% pull from home equity loan $30,000, now starting to get concerned, when will portfolio come back... Deploy: Side income, spending floor, home equity usage.

Let's just do a thought experiment.  You mentioned above you would be using the 4% rule.  So (just to keep things simple) you retire with a $1MM portfolio, which means you can withdraw $40,000/year, or about $3,333/month.

Now, comes 40% market crash you mentioned above.  Market crashes of that size tend to be rare, but also tend to take a quite a long time to recover.   The period 1973-80 for example, or from 2000-07.  But again just to keep things simple, let's say there's a 40% crash and your market recovery takes six years.

So you swing your plan into action.  Year one passes uneventfully.  On year two, you tap your HELOC and start borrowing $3,333/month at 4% interest.  At the end of six years, the market has fully recovered and you go back to living off your investments.   But, as a quick and dirty figure, I come up with a balance of $220,000 on your HELOC. 

The problem you can still only safely withdraw $3,333/month from your portfolio, but you have roughly $1,000/month in HELOC payments depending on the amortization schedule.   So you are now living only 2/3s of what you were living on.  How exactly did you improve your situation?   I guess your portfolio is a little bigger, but your lifestyle took a decades long face punch.   








Gonzo

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Re: Home equity line of credit - Strategy
« Reply #13 on: March 08, 2016, 07:28:06 PM »
Relying on credit for money you need to live is risky.  You may find the whole thing too stressful, depending on your risk tolerance.  There is no guarantee that a downturn will be short lived.  You'll be eating your house. 

HELOCs have a 10 year draw period (or at least, not unlimited).  They also have various repayment terms.  Mine requires a 2% payment, like a credit card.  Some are interest only. 

Having a HELOC is no assurance that you can actually draw the money when you need it.  HELOCs will not necessarily be available in a serious tightening or economic downturn.  To actually know you have the money, you would need to carry the loan, along with the associated costs of doing that. 

You may be able to borrow more cheaply than a HELOC.  Margin loans and promotional/subsidized credit come to mind. 






AZryan

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Re: Home equity line of credit - Strategy
« Reply #14 on: March 09, 2016, 12:01:46 PM »
Telecaster,
You basically keep repeating that dabears' idea is 'terrible' and then keep ignoring the details they write clearly showing all the variables they're reasonably factoring in. not cool


Personally, I just renewed a 10yr. line of credit for a similar strategy of having it as a back-up/safety net during the super critical 'sequence of returns' risk in the first decade of retirement.

I did it now while not quite retired yet, so I could still show normal job income.

Yes, it's a variable interest rate (4% as of now). It costs almost nothing, and should easily pay for itself if I use it during market drops greater than the current and future interest rate. But I don't intend to use it unless the market drops at least 15%. And probably not until a real ~20%+ crash.
Do you really think the interest rate will then suddenly shoot up over 20%??

You wrote, "-At the end of six years, the market has fully recovered and you go back to living off your investments.-
-I come up with a balance of $220,000 on your HELOC.
-you can still only safely withdraw $3,333/month from your portfolio, but you have roughly $1,000 in HELOC payments-
-So you are now living (on) only 2/3's of what you were living on.-"

Even if someone took a ridiculous $220K from the credit line during a huge crash at the very beginning of retirement (few here would), you act like the retiree wouldn't have a single penny extra to pay that off with?

You wrote, "I guess your portfolio is a little bigger, but your lifestyle took a decades long face punch."

You don't seem to understand just how much 'bigger' the portfolio would be. It's not 'little'.

You should be able to pull all you owe out of your investments when the market recovers (though this does depend on your own taxes). The 4% "rule" already expected that you've been pulling that money out all those six years.

Paying off the credit line 100% right then and there leaves your portfolio with more money than you would've had if you'd just blindly followed the market down and back up (again, unless interest rates suddenly jump to unheard of/ inane levels -and then the whole thing would probably be more of a 'wash' than a 'loss').
But somehow you think it'll cause a "decades long face punch"??

No... you could just go right back to the 4% rule with zero debt and a portfolio that only had a drop equal to the interest rate rather than the huge crash that happened, the market's in recovery and you're only 4 years from getting past that first super critical decade of risk.

AZryan

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Re: Home equity line of credit - Strategy
« Reply #15 on: March 09, 2016, 12:26:03 PM »
Quote from: whodidntante
Relying on credit for money you need to live is risky.

Uh... relying on the stock market for money you need to live on is risky. But which is 'riskier' -borrowing a few years of money at a modestly lowish interest rate, or pulling money from a market that's crashing 20, 30, 40, 50%? The contest isn't even close.

It's almost certainly going to be worth doing at least for a couple years if a crash happens during the first few years of early retirement. It's like having a huge 'virtual' pile of cash that doesn't have inflation losses until you trigger it into 'existence' by using it (because of a dot.com bust or Great Recession where your actual money just lost HUGE value, but you reasonably expect to come back soon enough).

Quote from: whodidntante
You may find the whole thing too stressful, depending on your risk tolerance. There is no guarantee that a downturn will be short lived. You'll be eating your house.

You may find retiring early too stressful. I don't see how mitigating a huge market portfolio loss would likely add more stress, rather than directly relieving it?

And if a downturn is that big and isn't short-lived -say more than 4 years- we'd all probably have to rethink how much we're spending and 'try to guess' if we're sinking too low to climb back up.

And, no, you're not 'eating your house'. At worst, you're a few years income in debt, and you could just pay it off with your investments if you really needed to. But you didn't want to use the portfolio because it crashed in value.

Jack

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Re: Home equity line of credit - Strategy
« Reply #16 on: March 09, 2016, 04:15:12 PM »
Instead of screwing around with a HELOC, if I wanted more risk / more reward (which it seems you do) I'd just take out a new, normal 15- or 30-year fixed-rate mortgage (now, not waiting to time the market) and invest the proceeds.

dabears847

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Re: Home equity line of credit - Strategy
« Reply #17 on: March 09, 2016, 07:14:12 PM »
Instead of screwing around with a HELOC, if I wanted more risk / more reward (which it seems you do) I'd just take out a new, normal 15- or 30-year fixed-rate mortgage (now, not waiting to time the market) and invest the proceeds.

I'm already taking risk and reward by retiring early but rather would a heloc offer some value if a market took a downturn while I'm drawing a consistent 4 percent or a withdrawal with a floor with or without a heloc. Benefits include ability to move - south like ATL warmer weather, not pay interest until I need the funds etc.

AZryan

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Re: Home equity line of credit - Strategy
« Reply #18 on: March 09, 2016, 11:09:36 PM »
Quote from: Jack
Instead of screwing around with a HELOC, if I wanted more risk / more reward (which it seems you do) I'd just take out a new, normal 15- or 30-year fixed-rate mortgage (now, not waiting to time the market) and invest the proceeds.

Wow. Hey Jack, maybe before making your three THOUSAND and sixth post here, you might want to work on reading what the people you reply to actually posted, and also understanding how completely different a HELOC option sitting unused on hold is from getting a new, standard home mortgage.

debears isn't trying to game the system or time the market. and a home mortgage would immediately saddle you with a huge new debt and big monthly bills. It would take some extra very specific factors for that idea to not be far riskier. It's essentially a different topic if leveraging the value of your home at say 3.5% interest for 30 years is brilliant just to invest it in a market possibly making little more for its Constant Annual Growth Rate.

It's not about trying to time things in any way, or extra screwing around with anything. I spent like 20 min. applying for a HELOC, got it, and it just sits there doing nothing until I ever feel it becomes useful in retirement -like if the market happens to have a massive crash that I didn't forecast or 'time'. I merely understood that such a downturn sometime in the next decade is quite possible and poses just about the only significant financial risk to early retirement. If interest rates are still reasonably low at the time (I'm guessing that super likely, but we'll all find out when the future arrives), the HELOC becomes an excellent instant diversifier to the rest of my sinking portfolio.

Another Reader

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Re: Home equity line of credit - Strategy
« Reply #19 on: March 10, 2016, 07:04:30 AM »
People that confuse current credit availability with long term liquidity risk learning the difference the hard way.  Looking forward to buying the assets of those that get caught by failing to recognize the difference at fire sale prices.

Telecaster

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Re: Home equity line of credit - Strategy
« Reply #20 on: March 10, 2016, 11:47:49 AM »
Even if someone took a ridiculous $220K from the credit line during a huge crash at the very beginning of retirement (few here would), you act like the retiree wouldn't have a single penny extra to pay that off with?

You wrote, "I guess your portfolio is a little bigger, but your lifestyle took a decades long face punch."

You don't seem to understand just how much 'bigger' the portfolio would be. It's not 'little'.

You should be able to pull all you owe out of your investments when the market recovers (though this does depend on your own taxes). The 4% "rule" already expected that you've been pulling that money out all those six years.

Hold on. Read what I wrote.  I assumed the OP would begin tapping the HELOC during a large market downturn, and start making monthly withdrawals until the market recovered, which was five years in my example.  That turns out to be $220,000 compounded (roughly speaking).

Can markets take that long from peak to recovery?  You bet.  Longer even.  2007-2013 and 1970-80 are two recent examples.   You can see that my five year example might have been too generous, and you could easily wind up with a whopping HELOC balance by following this scheme.

Next, the OP said he would be following the 4% rule, a central assumption of that rule is the 4% means 4% of the initial balance (inflation adjusted).  So that's what I thought his withdrawal rate would be.   But you're saying that's not true at all, and your strategy actually entails making very large withdrawals after market recoveries.   Borrowing money during market down periods and then making large lump sum withdrawals is a lot of things, but it ain't even in the zip code as the 4% rule.   It is a radically different strategy.  So, you need to cut us break for not realizing when you say "4% rule" you're not talking about the same 4% rule as the rest of us, you're talking about some other strategy that only you know about.   Thanks for filling us in, but no need to get snippy just because we can't read your mind.   

By the way, have you backtested this large, irregular withdrawal strategy?  For some reason, I'm thinking you haven't.   

Next, you said something about how this strategy works unless interest rates go to unseen levels.  Do you mean unseen or unseen by you?  For a lot of decades, mortgage interest rates were around 6-8%.   It is pretty reasonable to assume they will be back there someday, maybe sooner than we think.   And something else to keep in mind, interest rates tend to rise in times of economic or political turmoil, which is the time when markets tend to fall.

Remember the 1973-80 period I mentioned earlier?  Mortgage interest rates started off normal 6-8%, but then shot up to 12% by the end of that period.  And then they went a lot higher after that.   That really wasn't very long ago.   Maybe your scheme will work, maybe it won't.   But I definitely wouldn't plan on it being there for you when you need it.   






dabears847

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Re: Home equity line of credit - Strategy
« Reply #21 on: March 10, 2016, 05:25:33 PM »
Even if someone took a ridiculous $220K from the credit line during a huge crash at the very beginning of retirement (few here would), you act like the retiree wouldn't have a single penny extra to pay that off with?

You wrote, "I guess your portfolio is a little bigger, but your lifestyle took a decades long face punch."

You don't seem to understand just how much 'bigger' the portfolio would be. It's not 'little'.

You should be able to pull all you owe out of your investments when the market recovers (though this does depend on your own taxes). The 4% "rule" already expected that you've been pulling that money out all those six years.

Hold on. Read what I wrote.  I assumed the OP would begin tapping the HELOC during a large market downturn, and start making monthly withdrawals until the market recovered, which was five years in my example.  That turns out to be $220,000 compounded (roughly speaking).

Can markets take that long from peak to recovery?  You bet.  Longer even.  2007-2013 and 1970-80 are two recent examples.   You can see that my five year example might have been too generous, and you could easily wind up with a whopping HELOC balance by following this scheme.

Next, the OP said he would be following the 4% rule, a central assumption of that rule is the 4% means 4% of the initial balance (inflation adjusted).  So that's what I thought his withdrawal rate would be.   But you're saying that's not true at all, and your strategy actually entails making very large withdrawals after market recoveries.   Borrowing money during market down periods and then making large lump sum withdrawals is a lot of things, but it ain't even in the zip code as the 4% rule.   It is a radically different strategy.  So, you need to cut us break for not realizing when you say "4% rule" you're not talking about the same 4% rule as the rest of us, you're talking about some other strategy that only you know about.   Thanks for filling us in, but no need to get snippy just because we can't read your mind.   

By the way, have you backtested this large, irregular withdrawal strategy?  For some reason, I'm thinking you haven't.   

Next, you said something about how this strategy works unless interest rates go to unseen levels.  Do you mean unseen or unseen by you?  For a lot of decades, mortgage interest rates were around 6-8%.   It is pretty reasonable to assume they will be back there someday, maybe sooner than we think.   And something else to keep in mind, interest rates tend to rise in times of economic or political turmoil, which is the time when markets tend to fall.

Remember the 1973-80 period I mentioned earlier?  Mortgage interest rates started off normal 6-8%, but then shot up to 12% by the end of that period.  And then they went a lot higher after that.   That really wasn't very long ago.   Maybe your scheme will work, maybe it won't.   But I definitely wouldn't plan on it being there for you when you need it.

Well, the first bullet and subsequent bullets refer to a floor and ceiling, 4% withdrawal with a cap and floor.

Rates could go up but lock options are available. There are talks of stagflation in the economy and potential for negative rates. There are so many directions the market and economy could go.

I created a little excel sheet to look review the numbers, take a look and let me know your thoughts. I built it out for only 1 year normal withdrawal and two year down market.                
   
Portfolio Gain            $29,250.00   with heloc