Elaine E. Bedel
President, Bedel Financial Consulting
There are two schools of thought regarding residential mortgages during your retirement years. One says it is a sound financial strategy to retain the mortgage, while the other prefers the security and peace of mind that is a result of being mortgage-free. Which works for you?
Reasons to Keep a Mortgage in Retirement
• Maximizing Investment Return. If you have a low mortgage rate, it makes sense to invest extra funds in an investment vehicle that would earn a higher total return. If you pay off your mortgage, your investment return is equal to the mortgage interest rate. For example, if your mortgage rate is 5.5%, you must ask yourself if you can earn a higher return by investing the funds elsewhere. You should compare your mortgage rate to other long-term investment rates of return. If you are comfortable with the risk/return of a higher-yielding investment vehicle, then it is beneficial to invest the extra funds instead of paying off the mortgage.
• Mortgage Interest is Deductible. In the 1980's, tax law changes eliminated the deductibility of most types of interest, leaving only residential mortgage interest as deductible on your income tax return. Therefore, it is better to borrow against your home equity to purchase a car, make home improvements, or finance other large ticket items, rather than to secure a non-deductible car loan or other personal loan in retirement. After the income tax savings, a mortgage interest rate of 7% will net down to approximately 5%, making a home equity loan more cost effective than a car loan with a rate of 6.5%.
• Forced Savings. For some homeowners, paying the mortgage is a type of forced savings. With each payment, some amount of principle is being paid down on the loan, therefore, increasing the equity in the home. If the house is also appreciating in value, the equity continues to grow.
Reasons to Pay-Off the Mortgage Prior to Retirement
• Reduce Living Expenses. A mortgage payment generally represents 20% to 30% of the monthly budget. With the mortgage paid off, the monthly expenses become more manageable in retirement, especially if the retiree is on a fixed income budget.
• Nest Egg for Long-term Care. The equity in a home is considered by many to be a resource for providing for long-term care or other emergencies. In the event the retiree needs to move into an assisted living facility, the home equity can be tapped either by selling the residence or securing a reverse mortgage.
• Financial Security. Pure and simple, many people are more comfortable without a mortgage in retirement. The security of knowing that the house is paid for reduces the financial stress of retirement.
If you believe you would like to be mortgage free in retirement, begin to plan now. If your existing mortgage extends beyond your expected retirement date, there are several strategies you can employ.
• Consider Refinancing. If you are in your mid 40s and on the front end of a thirty year mortgage, you many want to consider refinancing to a fifteen year mortgage. Many Baby Boomers have initiated this strategy. The mortgage interest rate is generally lower for a fifteen-year versus a thirty-year mortgage, but the monthly payments may be higher. Therefore, it is important that you consider the impact of the new payment on your cash flow.
• Prepay Principal. Most mortgage lenders will allow borrowers to make additional principal payments each month. This will decrease the life of the loan as well as reduce your overall interest charges. If your current mortgage rate is lower than the rate of a new mortgage, paying additional principal each month is a better option than refinancing.
• Bi-weekly Payment Plans. You can set-up your loan payments to be made every two weeks instead of once a month. Each payment is equal to half of your normal mortgage payment. Since there are 52 weeks in a year, you will make 26 half payments. This results in 13 full payments versus the normal 12 monthly payments. The extra payment will allow you to pay off the mortgage early. Since there are extra fees required by the lenders to establish this bi-weekly program, it is generally better to make extra principal payments each month rather than pay the set-up fees. However, for some homeowners who are paid every two weeks, this mortgage payment cycle may be more manageable.
Almost 70% of Americans own their homes. Of the owners, 35% are mortgage free. According to the AARP, of those households headed by someone age 75 or older, three-fourths have no debt. If you prefer the peace of mind of being mortgage-free in retirement, review your situation today and take the necessary steps to achieve that goal.