mortgage in retirement

[M Paquette]

I never really bought into 'carry a mortgage to get a tax deduction'. I should pay $6,000 a year in interest so I can get back a thousand or so. Now if you have to have the mortgage to afford the house, then it is a nice discount, but, imho, never to save money on taxes.

Amen!

Even worse, you really need to look at the tax numbers to see if you'll even get to take that interest deduction. My dad had always said that he wanted to have a mortgage for the tax deduction, and had gone to some trouble to keep a mortgage even when moving to their retirement location, where they could have paid cash from the sale of the old home. (The cash went into an annuity. )

When I wrapped up my parent's estate I recovered all the old tax returns., all professionally done by a CPA they liked. For every year, going back some 20 years, the standard deduction was a better deal than itemizing and taking the mortgage interest deduction, and so the CPA used the standard deduction. He never saved a penny from all that mortgage interest.

 

[Katsmeow]

Obviously, a tax deduction is not a good reason by itself to take a mortgage. It is a factor that you consider in determining the total cost of the mortgage.

One factor for those buying/building a house near retirement is whether there is the cash to pay for it that is not in retirement accounts.

We bought our retirement house a year ago, paying cash, partly from money in taxable accounts and partly from money in retirement accounts. Of course we have to pay tax on the money from the retirement accounts (no penalty as DH is over 59 1/2).

We have since determined that we need to tear down the house (originally we were going to extensively remodel it) and build. We still debate whether to take a loan or pay cash. The negative to paying cash is that we would have to take it from retirement accounts and pay tax and it would throw us into the highest tax bracket for the year.

The positive to a loan is that we could pay it off (if we chose) over a few years to lower the tax hit and would keep more of our money invested in the retirement accounts.

My analysis basically seems to come out better if we take the money out and pay cash but doing so would use up almost 1/3 of our retirement accounts so I'm reluctant to do it even so...

Still thinking about it....

 

[Nords]

I know there may be cases where this is impossible or doesn't make sense but leverage is generally not good in retirement, IMHO.

I think the discussion is being muddied up by the vocabulary.

Retirement has nothing to do with debt or leverage-- retirement has to do with whether or not you're choosing to chase a paycheck. You may not yet be financially independent or you may be donating those paychecks to charity, but that's how you define whether or not you're retired.

The issue with debt/leverage during retirement is that most retirees do not have (1) sufficient and (2) reliable cash flow to service the debt, and (3) no need to do so. It may be sufficient but subject to stock-market volatility. It may be reliable but Social Security is a tough way to pay a mortgage. The decision has an emotional component as well as a financial one-- it may be something they could swing financially (despite (1) & (2)) but they would have trouble sleeping at night.

Thanks to my [-]foolishness[/-] willingness to provide target services for the federal govt for 20 years, I now have both a sufficient and a reliable cash flow to service some debt. My pension's COLA and our serial refinancings have reduced our home mortgage payment to less than half my pension. Our rental's mortgage provides a nice balance of cash flow and minimal Schedule E taxable income.

(3) is still an issue, and I don't have an answer for it. We could pay off all the mortgage debt tomorrow but we see no reason to do so. In fact, paying 3.625% fixed for 30 years seems like the investment opportunity of a lifetime. I can beat that over a 30-year period with CDs, let alone with Berkshire Hathaway. Maybe we should've borrowed more, but we saw no reason to leverage even higher.

The (3) conundrum is this: If you don't need the money then you could take extra investing risks with it. But if you don't need the money, then why risk losing it all? Like I said, I don't have the answer. Until I find an answer, I'm not uncomfortable with being financially compensated for risking unneeded assets.

 

[bcinvest]

I would not want a mortgage. Reduces your flexibility. Of course being debt free is better.

I believe you are confusing personal preference with economic reality. Being debt free may or may not be better. It depends on what you can do with the money. In this environment leverage is a great idea. It maintains flexibility.

 

[haha]

I read the article. I agree that most of us do not want to use mortgage proceeds to effectively finance equities in retirement. This may be a fine strategy with a job, or with what is even better than a job, a good retirement pension. A government retiree for example has a more or less guaranteed long term profit by offsetting the largest mortgage she can get with her pension. 100%, if the bank would lend it.

But for retirees who are largely portfolio financed, the only prudent course is to offset the mortgage with risk free assets, at least with respect to credit risk though not necessariy interest rate or quotation risk. But almost always, the rate at which you can invest your money risk free will be less than what you pay on your mortgage when contemporaneously compared. ( A graph in the article shows this.)This is also the sound argument frequently made on this board for paying off a mortgage in retirement.

There is a maturity arbitrage available with a fixed low rate mortgage that involves paying the varying cost of carry while you invest in short term risk free instruments, in hopes of seeing an opportunitly to invest at long term (or short term) interest rates high enough to give an after tax negative cost of carry on the mortgage. To be worth doing, one would probably want to lock in a longer term rate for the duration of the mortgage when the spread becomes profitible. This would then be analgous to defeasement.

What I can't figure out is how long can Bernanke et al keep the lid on rates? We know they will move heaven and earth to sit on them; the only question is "Can they succeed?" So far it appears that yes they can.

For most of us, the game may not be worth the candle.

Ha

 

[Rustic23]

I think Bernake can sit on rates as long as the unemployment rate stays high. As the that rate goes down, inflation will go up, and he will be forced to raise interest rate.

 

[Danmar]

Some good posts. Maybe my opinion is based on the fact that in Canada there are no long term mortgages-ie although the amortization periods can be up to 30 years, the intetest rates are set at periods generally less than 5 years. So rate risk is a concern. I recall the early 80's when my mortgage reset at 17%! I can see your point Nords. I also have a secure pension and could easily afford to put a mortgage on one of my properties. I would need to invest the proceeds in something. To be prudent it would need to be in FI. I think I would lose on the spread? If I invested in equities it would increase my risk. The interest on the mortgage would be fully deductible if I invested the proceeds. Doesn't make sense for me. So if it doesn't make sense to get a new mortgage, and it doesn't make sense to pay a mortgage off, which is the answer? Maybe it depends on one's means vs desired life style?

 

[Nords]

I think I would lose on the spread? If I invested in equities it would increase my risk. The interest on the mortgage would be fully deductible if I invested the proceeds. Doesn't make sense for me. So if it doesn't make sense to get a new mortgage, and it doesn't make sense to pay a mortgage off, which is the answer? Maybe it depends on one's means vs desired life style?

I think it makes sense to take advantage of the lowest long-term borrowing costs that I'm likely to see for the rest of my life.

I've said that after each one of our 10 refis on our two properties over the last 18 years...

 

[Danmar]

So I've been thinking some more about this question. A mortgage is debt like a credit card only better rate. I agree if you are going to have a mortgage it's better to have the lowest rate-So refi's make sense. But it represents in most cases money you have already spent and cannot spend again unless and untill you pay the mortgage off. I realize many people don't view a mortgage as debt (often hear no debt ...well other than the mortgage) but it is. This is what I mean by it reduces your flexibility. By having a mortgage you have levered up and increased your financial risk. This reduces your ability to take on other financial risk in the future. So I ask the question again: isn't it better to pay your morgage off before you retire? After all this is a corollary of the LBYM culture right.

 

[samclem]

This is what I mean by it reduces your flexibility. By having a mortgage you have levered up and increased your financial risk.

I'm not sure I understand your use of the words "risk" and "flexibility" here.

Person A: Retired. $200K mortgage, $200K savings in a taxable account, $500K in IRAs and 401Ks

Person B: Retired. Formerly had the same mix as Person A, but paid off the $200K mortgage with his $200K in the regular taxable account. So, now he has a paid-off house and $500K in dedicated retirement accounts.

Which person has more flexibility? If a $100K medical expense comes up, or a sudden desire for a $20K vacation hits, I'd rather have the cash available. If inflation goes to 12%, I'd like to have a $200K 5% mortgage (paying the loan off with money that is worth less and less each month) and also be able to invest that $200K in my accounts in a way that will offer me some hope of staying even with inflation so my investments can still provide enough earnings to keep food on the table for 40+ years.

Having a mortgage isn't always the right choice, but it is best to carefully consider all the options rather than simply deciding that "less debt is better."

I swear I'm no dirty market timer, but I do "lust in my heart" and have a hard time believing we won't look back on these incredibly low mortgage rates as the opportunity of a lifetime. Just as we look back in awe at 16%+ CD rates of the early 80's and say "why didn't I load up on those?" Of course, the real return on those securities wasn't that phenomenal since inflation was going crazy and threatened to go even crazier. With mortgages, its just the opposite right now--does anybody really think we'll have decades of deflation, or is it more likely prices will be a lot higher over the coming decades?

 

[chinaco]

Ripper1

1. Is the total pension for you and your DW $70k? No other source of income?
2. How old are you and your DW?
3. Is the pension reduced for the survivor?
4. Is the pension and cola reliable?
5. How much money (excluding the mortgage) do you need to live?

For now let's assume that the answers to (Q1) is $70k is the only income and (Q3) the pension is not reduced for the survivor (Q4) the pension is solid and reliable.... Let's also assume that you you keep your 457 plan money for longer term emergency money and do not spend it.

Let's play with the math.

If you pay 100k down on the home that leaves a mortgage of $250k. The payment at 5% for 30 years would be about $16k/yr. Add property tax and insurance to it. Let's assume that those two will be 7k/year. That is a total of $21k/year. (this does not include other purchases.. new furniture or other stuff... just the ongoing cost of the house).


$70k - $21k = 49k/year

Could you live on $49k gross per year (after the mortgage, prop tax, and insurance)?

 

[chinaco]

The concept of dream home...

For some it is a new bigger home...

We did that when we bought our current home.... We own it outright. But now our version of dream home is to downsize from it and simplify.

 

[Danmar]

Sam: If you pay your mortgage off you can always get another. Agree there is a possibility the rate could be higher. I think you would always want enough liquidity on hand to cover emergencies. If the only way to do this is keep the mortgage I can see that. I would cover this by getting a HELOC and not drawing unless required. In my opinion debt is debt and in retirement you are better without it. I understand the view that locking into a 30 year mortgage at these rates sounds good. However, I still think being debt free is a better place to be.Borrowing inherently increases your risk as you have increased your fixed expenses much like buying investments with a margin loan(albeit without the possibility of margin call).

 

[bcinvest]

I'm not sure I understand your use of the words "risk" and "flexibility" here.

Person A: Retired. $200K mortgage, $200K savings in a taxable account, $500K in IRAs and 401Ks

Person B: Retired. Formerly had the same mix as Person A, but paid off the $200K mortgage with his $200K in the regular taxable account. So, now he has a paid-off house and $500K in dedicated retirement accounts.

Which person has more flexibility? If a $100K medical expense comes up, or a sudden desire for a $20K vacation hits, I'd rather have the cash available. If inflation goes to 12%, I'd like to have a $200K 5% mortgage (paying the loan off with money that is worth less and less each month) and also be able to invest that $200K in my accounts in a way that will offer me some hope of staying even with inflation so my investments can still provide enough earnings to keep food on the table for 40+ years.

I agree wholeheartedly. Mortgage gives you much more flexibility. You have the cash or have foregone the expenditure of cash. You never know if you will be able get one when you need it most. There is no guarantee that you will be able to get a mortgage when you need the money.

 

[Bestwifeever]

Sam: If you pay your mortgage off you can always get another. ...

Perhaps, but income in retirement may be reduced so one might not qualify. Also, interest rates sooner or later will go up; someone with today's low interest rates would have much higher monthly payments as a result.

 

[Katsmeow]

Perhaps, but income in retirement may be reduced so one might not qualify. Also, interest rates sooner or later will go up; someone with today's low interest rates would have much higher monthly payments as a result.

This is part of my current conundrum. I keep turning it over in my head as to what is best.

We currently own one house with mortgage. For long term financial viability we must sell this house. Right now I'm working part time and it covers the cost of the house and right now I enjoy working part time. But, I don't want to feel forced to do it. While we have a mortgage on House 1 we can't possibly qualify for a mortgage on the House 2 (the house we plan to build).

But-- sell House 1 and while working part time we could qualify for a mortgage on House 2.

Our options:

1. Build House 2 with a mortgage. To do this we have to defer building until House 1 is sold so will have costs for somewhere to live while we are building (we have 5 dogs and 2 cats so finding somewhere is not a trivial problem). Also, to long term have a mortgage even at low rates will certainly cut into our spending power. That is, money will have to go for interest on a mortgage that is an expense we wouldn't have without a mortgage. And, needing to take more money out of retirement accounts for a mortgage increases our taxable income each year with various negatives to that. The positive to this is that our taxable income is increased each year but the extra income to pay the mortgage may not throw us into a higher tax bracket. Also, we still have our complete portfolio to invest.

2. Build House 2 for cash (fundamentally this works out the same as paying off the mortgage on an existing house). I would prefer to do this in many ways. I think interest on a mortgage is an expense I don't want to have and I prefer to not forever have to have increased income to sustain a mortgage. The way I see it is that if I am paying say $15000 a year in a mortgage (after considering tax benefits), I need an additional $375,000 in my portfolio to sustain it. And if we do this and wanted a mortgage years from now, if I quit work at some point, we might not be able to qualify.

The big rub for me -- that not many talk about when debating whether to pay off the mortgage -- is that all of our funds are in tax deferred accounts. So let's say it will cost $275k to build the house we want to build. The total cost is closer to $400k once you include the taxes. And, in our case that is about 30% of our portfolio.

But doing this does reduce our expenses in retirement since don't have to service a mortgage. Also, it can be argued that it is false to include the entire $125k in taxes as part of the "cost" of building. To build in one year and pay the building cost in cash does result in us being in a higher marginal tax bracket for that year and higher taxes overall. However, if we have a mortgage we will have to draw out money each year to pay it and we will likely be in the 25% tax bracket. So, it really only the difference in taxes between the two scenarios that is an extra cost.

On the other hand, imagine we got a mortgage and decided to pay it off in 10 years. We would have some income taxes each year at a 25% tax rate versus probably at 33% tax rate if we build for cash. But, in paying it out over 10 years we get some benefit for having the money invested over that time (albeit a declining amount each year).

Every time I've tried to run the numbers on this, it still comes out that building for cash works out best. However, I do have conservative numbers for investment returns.

 

[samclem]

And, needing to take more money out of retirement accounts for a mortgage increases our taxable income each year with various negatives to that.

I think this is a sometimes overlooked "con" of having a mortgage--folks forget to figure the taxes on the $$ that remains in investments rather than being used to pay off the mortgage.

One other thing--the possible "other benefits" of being at the low end of the income scale. No one knows what the government may do, but there have certainly been rumblings of a need for the "rich" to pay more, and frequent efforts to transfer resources to those at the lower end of the income scale (tax credits that phase out with income, bigger subsidies for heath insurance, etc). For these reasons, some people may find that reducing their income (by reducing their investments through paying down the mortgage) might pay off better in the future than at present.

Indeed--so many unknowns and unknowables.

 

[Nords]

Sam: If you pay your mortgage off you can always get another. Agree there is a possibility the rate could be higher.

I can't agree with this one. We were able to get two mortgages (one a rental and the other our residence) because we had two honkin' big incomes at the time and the lender didn't ask about our ER plans.

Every refi since then has been a perpetual debate regarding our interest/dividend income as well as our rental income. (I had to explain to one mortgage broker how we were boosting our income by selling covered calls... that didn't go so well.) The lender's bottom line in each situation was that the lower payments (and the lack of a cash-out refi) was improving our cash flow. This logic would not have worked if we were trying to "always get another mortgage".

So the easiest answer is to get a mortgage before you ER.

I think you would always want enough liquidity on hand to cover emergencies. If the only way to do this is keep the mortgage I can see that. I would cover this by getting a HELOC and not drawing unless required.

We do that too, but I wouldn't be so eager to arb a HELOC because they tend to have variable interest rates and shorter draws. Nothing beats today's 30-year fixed rates.

But what kind of emergency are we talking about? Many of us ERs carry at least a year's expenses in cash (we carry two) and some carry up to seven. Between a cash stash and a HELOC I'd think the average ER would be awash in emergency resources.

In my opinion debt is debt and in retirement you are better without it. I understand the view that locking into a 30 year mortgage at these rates sounds good. However, I still think being debt free is a better place to be.Borrowing inherently increases your risk as you have increased your fixed expenses much like buying investments with a margin loan(albeit without the possibility of margin call).

Increasing fixed expenses is only a problem if the increase is likely to wipe out your safety margin-- for example a pension without a COLA or no pension at all. Lenders have debt guidelines like "mortgage P&I no more than 28% of net income" and "total debt no more than 36% of net income".

Perhaps the issue is vocabulary, or math vs emotions. I won't claim that one reason is better than the other, and emotions usually triumph because if you can't sleep at night then logic & math just don't matter. But someone who "feels" and "thinks" that debt-free is better than a mortgage is not willing to go with the math and the probabilities. It would appear that my primary motivation is [-]greed[/-] putting a financial commitment behind my investment analysis.

Having a mortgage in ER comes down to a question of excess assets. If you have more money than you need... then should you take absolutely no risk at all with it, or should you take extra risk? I don't think there's a single (let alone simple) answer for everyone.

 

[lovinglife1]

During my earlier working years my strategy was to buy modest new homes, (15-200K), rent them out to produce income and support the mortgage payments, pay them off as soon as possible, then sell them at retirement to fund a 'dream house' for retirement.

As it turns out, i am a year from retirement, soaking up 40k in rental income a year. I have decided to buy the new home now and use the rentail income to pay the mortgage....so 6 of one, half a dozen of the other.

Since the value of the rental properties is more than the mortgage, I'm in like flint...

I am lucky in another respect. I have an excellent management company who has kept the rentals occupied 95% of the time and the fact the homes are pretty nice for the price levels and in good neighborhoods the tenants are very good. They are just people who may have high debt, or lower credit scores or something that keeps them from being able to buy a house at present.

 

[Danmar]

I think we are going to have to disagree on this one. Emotions/culture certainly play a role in this issue. Simply put, for me, being debt free is where I want to be now that I am retired. Had plenty of debt all through my working life and paying it off was always a major goal. Thanks for the thoughtful responses.

 

[Rustic23]

Debt is merely a tool. It is not good, despite what Dave Ramsey says, it is not bad, it is just a financial tool. It is how you use the tool that counts. And here I agree with Dave, most use it poorly.