Mortgage(s) in Retirement

[rayvt]

ERD50 & martyp: Exactly!

A lot of the "analyses" that people toss out are as sound as the people who say "I got a raise that put me into the next tax bracket and my taxes went up more than my raise was."

There have been countless throrough analyes of having vs. not having a mortgage in retirement, and they always show that there is only a trivial difference. So when somebody says that there is a BIG difference (like "need double the cash flow") it generally means that they have not done comprehensive calculations on the actual financial data but merely took a SWAG.

The thing that they usually get wrong is failing to realize that the money to pay off the mortgage principal would otherwise be in an investment or savings account.


When we were out today I got to wondering about this, and wondered, "If I had a $100K mortgage at 3.75%, and I needed to make the payments entirely by withdrawals from a savings account (consisting of CDs, bonds, etc.) how much money would I need in that account to start off with?" Note that you'd be drawing down principal from that account, rather than needing just the interest to make the mortgage payment. That's a different question.

Presuming that you had $100K in the account, which is what you'd use to pay off the mortgage today if you decided to, what interest rate would it have to earn so that it covered 100% of the mortgage payment?

So I fired up an on-line calculator and put the numbers in. What it said made me go . Duh!!
A savings account that you make monthly withdrawals from is the mirror image of a mortgage that you make monthly payments to. They are identical. The only difference is in which one is the payor and which one is the payee.

A $100K 30 year mortgage is a payment of $463.12/mo. An investment account that starts off with $100K, earning 3.75%, with a monthly withdrawal of $463 is depleted to zero in 30 years.
It's a wash!

But, what if your account can earn 5.0%? Taking that same $463 monthly withdrawal to make the mortgage payment, after 30 years the account balance is $60K. So you paid off your $100K mortgage but depleted the account by only $40K.

What if your account can earn 6%? You'd make the same $463/mo withdrawal to make the mortgage payment, after 30 years the mortgage would be paid off, and your account balance would be $135K.

This is the kind of analysis that astute money managers go through in deciding whether to pay off the mortgage or keep the mortgage and keep the money invested. If you can earn more than 3.75% on your investments, the financially superior thing is to have the mortgage. You don't have to worry about making the payments, and you don't have to double your cash flow (since the cash inflow from the investments balances the cash outflow for the mortgage).

Of course, there is more to life than finances. Emotionally, some people would rather not have the mortgage payment and don't want to be concerned about balancing out investment cash flows.

 

[ERD50]

Where does that larger portfolio comes from? To keep the mortgage, you need to save $300K. To pay off the mortgage you only need to save $215K. So why save more, when you can achieve the same result quicker and with less money?

Well, I was just trying to understand the framing of that 'double the cash flow' statement from the earlier poster.

Clearly, if one does not think that there is a reasonable chance that their investment returns will exceed the mortgage costs, they shouldn't do this. Remember that not all that cash flow is an expense, some of it (the principal) is just shifting from one asset (your portfolio) to another asset (your house).

In any case, to pay off $X of a mortgage means you have $X less in your liquid portfolio, and less potential income from that smaller portfolio. That's all. It seems to me that many posters only look at one side of the equation.

-ERD50

 

[rayvt]

But there's another valid situation. Suppose somebody says, "But I don't want to deplete my investment/savings account with the withdrawals for making the mortgage payments. I don't want to touch my principal."

How much money do you need in the account so that the withdrawals cover the mortgage but don't eat into the principal, if the account earns 5.0%?

$112,000.

That's all. After 30 years of making mortgage payments from the account, the mortgage is completely paid off and the account balance is $113,000.

You can have your cake and eat it too.

This is why somebody who retires with a large net worth doesn't have any pressure to have a paid-off mortgage. They need $X to support their 4% SWR (which they need with or without a mortgage) plus an addition sum that amounts to 12% more than the mortgage balance.

If you need $3000/mo income (not counting the mortgage payment) from the 4% SWR, then your investment account needs to be $900K. That means that if you have a $100K mortgage, your initial nest-egg would have to be $1,000,000, so that you have 900K after paying off the mortgage.

But, if your initial nest-egg is $1,013,000, then it is a wash because you carve out $113K for the mortgage-payoff account, leaving you with the same $900K to support your 4% SWR.

Now, in the big scheme of things there's not much difference between $1,000,000 and $1,013,000. That's only 1.3% more than a million. That's why people that are not retiring on a showstring don't get all excited about paying off the mortgage. If you've been able to build up your liquid net worth to a million, then building it up to a million and thirteen instead is not a big deal.

 

[rbmrtn]

Well, I was just trying to understand the framing of that 'double the cash flow' statement from the earlier poster.

-ERD50

I meant I would need to generate twice the income from investments to cover living expenses plus a mortgage payment versus living expenses only. You seem to be assuming you'll have some excess return from your larger portfolio. That may or may not happen. Paying of the mortgage is a sure thing.

 

[Nords]

Presuming that you had $100K in the account, which is what you'd use to pay off the mortgage today if you decided to, what interest rate would it have to earn so that it covered 100% of the mortgage payment?

I guess that would have to be an after-tax interest rate, not the APY offered by the financial institution.

 

[foxfirev5]

My DW and I paid off our houses several years ago and haven't looked back. We have a Heloc in case we need it but haven't so far. I have no interest in financing my home to make potentially higher returns than the mortgage%.
The way I see it a 30 year treasury is yielding about the same as the 30 year mortgage. In other words its a wash in my eyes. My home is where I live. I can take a drop in my investments but don't want to take on additional risk on my home.

 

[nun]

So for our particular situation, I find it very difficult to think of having a mortgage now when we have not had one for 13+ years. (Hence my original comments at the start of the thread) I guess it is the English in me (Second Reason), I (and I have now convinced my Canadian Wife over the years) do not like any form of debt. The Mortgage was the only debt we ever had. We just bought cars we could afford to buy outright, or as I was in Sales I wrote off my business cars and always leased those at the time. (A Lease is classified as a rental and is 100% tax deductible, or at least it was and I had a car allowance from work).

SWR

+1 I'm from Yorkshire so thrift comes naturally as well as a distain for debt. I've only ever had mortgage debt and I've never really liked that. I've owned 3 cars in my life and I paid cash for them all. I've never carried a credit card balance, and as I went to college in the UK back in the 1980s I graduated with money in the bank and no debt. With the mortgage is paid off the house produces net income from the downstairs rental. I'm free and clear.

 

[ERD50]

... You seem to be assuming you'll have some excess return from your larger portfolio. That may or may not happen. Paying of the mortgage is a sure thing.

Sure, as I said before, if you don't think you have some reasonable chance of your long-term portfolio returns exceeding these historically low mortgage rates, than pass.

Does your SWR reflect such pessimism? If not, it seems like a rather selective observation.

The way I see it a 30 year treasury is yielding about the same as the 30 year mortgage. In other words its a wash in my eyes. My home is where I live. I can take a drop in my investments but don't want to take on additional risk on my home.

My portfolio isn't in 30 year treasuries, and I wouldn't suggest that it is a good idea to take out a mortgage and invest it in something like that.

It's hard to see how having a mortgage that makes up maybe 10% ~ 20% of your portfolio will put your home at risk. That $215K mortgage I talked about earlier - if that $215K dropped in half (unlikely in a diversified portfolio), you can still pay the mortgage for ~ 9 years before touching any other principal. And you still need to pay your property taxes and maintenance and utilities out of that depleted portfolio. I don't think the paid for house protects you in such black/white terms, might even be a negative if inflation is the monster we face.

-ERD50

 

[Animorph]

Sounds like a lot of guys are adding the mortgage to their expenses and seeing how much it increases the portfolio they require to pay it off at a 2% to 3% WR. That's always going to favor paying off the mortgage.

 

[nun]

I always included extra principal payments as part of my AA. My mortgage was 4.5% and I figured that it was a guaranteed return, I just thought of it as part of my fixed income investments.

 

[WestLake]

It bothers me that I am paying principal PLUS interest with a mortgage. That interest over many years (and indeed mostly interest for many years) seems a waste to me.

 

[pb4uski]

It bothers me that I am paying principal PLUS interest with a mortgage. That interest over many years (and indeed mostly interest for many years) seems a waste to me.

More of a waste than paying rent?

Do you really expect to borrow money for free?

Or better yet, give me an amount equal to your investments and I'll make regular payments of principal to you (but no interest).

 

[l2ridehd]

I am retired. Have a mortgage on my primary home, my will move to retirement home when DW stops working, and two rental properties. Might payoff future retirement home when we sell current primary home. Then again might not. It all depends on taxable income and tax codes at that time.

It is a fairly easy calculation to make the determination. Current tax bracket, current mortgage rate, effective mortgage rate and current investment rate of return. If and when the effective mortgage interest rate becomes higher then the investment rate of return over a sustainable period of time then and only then will they be paid off.

I have moved then all but one to 15 year very low interest loans. The one I did not I am paying as if it were, but the savings didn't justify the actual refinance based on the low remaining balance.

So IMHO there are some very good reasons why someone might be retired and still have a mortgage. Each person needs to look at their current situation and make the best financial decision for them.

 

[nun]

It is a fairly easy calculation to make the determination. Current tax bracket, current mortgage rate, effective mortgage rate and current investment rate of return. If and when the effective mortgage interest rate becomes higher then the investment rate of return over a sustainable period of time then and only then will they be paid off.

I don't think it's that simple. What about your AA. Why not use the mortgage as part of your bond allocation. Paying it off will net you the mortgage interest rate. The return you get from equities isn't really applicable here, you should be comparing your mortgage rate with the return you get from your bonds.

 

[ERD50]

It bothers me that I am paying principal PLUS interest with a mortgage. That interest over many years (and indeed mostly interest for many years) seems a waste to me.

I see this as another example of only looking at one side of the equation. Sure there is interest, but there are also gains from the added money in your portfolio. Do the math, but take off the blinders first.

I don't think it's that simple. What about your AA. Why not use the mortgage as part of your bond allocation. Paying it off will net you the mortgage interest rate. The return you get from equities isn't really applicable here, you should be comparing your mortgage rate with the return you get from your bonds.

Many 'pay-off' people make this statement that you need to compare the mortgage to 'safe' bonds. I don't agree - I look at my overall AA. Sure, you can think of a mortgage payoff as '100% safe', but does that mean the money you invest HAS to be 100% safe? That is too much compartmentalizing for me. As an analogy, say you had a $1M portfolio invested 50/50 and you were happy with that AA. Then you inherited $500K that was invested in treasury bonds. Would you feel you HAD to keep it in treasuries, because that is how it came to you, or would you stick with your AA?

And if one really feels that mortgage = safe bonds, does that mean that you never invested a penny in stocks until the mortgage was paid off? Would you recc that to a young earner? To be consistent, it seems you are saying not to have any stocks at all until you pay off a mortgage, right?

-ERD50

 

[someguy]

the great debate

I know most of the folks on here are way past this in terms of sophistication, but keep in mind paying off the mortgage doesn't mean you are free and clear, either in terms of having no monthly costs for basic housing, or that you are completely safe from losing your home.

Obviously it depends where you live, but, for example, at 3.5% and with LTV a little under 80%, over 40% of our monthly payment is for RE taxes and insurance. So if we paid off our balance today, it would remove 60% of our current payment, not 100%.

On the second front, if we fail to make our RE tax payments (which are the majority of the 40% that remains), we still eventually lose our house, just like if we don't make the PI payment to the bank when having a mortgage.

As far as the debate going on about cash flow and funds in some kind of retirement account versus going to pay the mortgage, I think the main factor that I haven't seen mentioned directly is the ratio of the PI portion of mortgage payment to liquid net worth. Or ratio of PI to income being saved if you are pre-retirement.

If you are saving a large portion of your income and your mortgage expense is a small percentage of your income, I think you're more likely to want (emotionally and financially) to carry a mortgage into and through ER/R.

For example, if our PITI is 6 or 7% of income and we're saving 50% or more of our income, carrying that 6-7% into ER/R isn't really a big deal. And based on the fact that paying off a mortgage (for us) only eliminates 60% of PITI, that is actually 3.6-4% being carried into retirement.

On the other hand, if our PITI is 35% of income and we're saving 15% of our total income, carrying that 21% (35 * 60%) PI into ER/R is going to be a lot more of a burden.

Obviously this is just a fancy way of restating the idea of L(way)BYM. The other factor, rate of return on other investments versus the mortgage rate has been pretty thoroughly discussed, so I will simply add that being in the first example above may allow one to tolerate more risk and therefore widen the gap between a 3.5% mortgage and whatever the other options are. Certainly for us it has. I expect traditional equity/bond investing to somewhat beat 3.5%. Our real estate investments have thus far substantially beat 3.5%, and investments into our small business have destroyed 3.5%. But that obviously varies widely from person to person.

 

[nun]

Many 'pay-off' people make this statement that you need to compare the mortgage to 'safe' bonds. I don't agree - I look at my overall AA. Sure, you can think of a mortgage payoff as '100% safe', but does that mean the money you invest HAS to be 100% safe? That is too much compartmentalizing for me. As an analogy, say you had a $1M portfolio invested 50/50 and you were happy with that AA. Then you inherited $500K that was invested in treasury bonds. Would you feel you HAD to keep it in treasuries, because that is how it came to you, or would you stick with your AA?

-ERD50

I'd stick with my AA. If you have a 50/50 AA why not just take the money you dollar cost average into bonds and apply it to the mortgage. You're keeping the AA if you think of the mortgage and it's return as part of your bond allocation.

 

[Danmar]

My DW and I paid off our houses several years ago and haven't looked back. We have a Heloc in case we need it but haven't so far. I have no interest in financing my home to make potentially higher returns than the mortgage%.
The way I see it a 30 year treasury is yielding about the same as the 30 year mortgage. In other words its a wash in my eyes. My home is where I live. I can take a drop in my investments but don't want to take on additional risk on my home.

Same point of view as I have. People may be able to earn more on their investments than the mortgage cost but this is not guaranteed and increases risk as any leverage does. Furthmore even if you made a few percentage points on your spread is it reall worth the risk? I say no. It think it does get tougher to pay your mortgage off after retirement as you worry about reducing your portfolio and like the prospect of higher security gains. Much easier to pay it off while working out of employment cash flow that otherwise would have been spent on other things. Any ways in a perfect world wouldn't you rather be debt free?

 

[Bestwifeever]

Call me stupid but I really like not having a mortgage for us (I think it's just splendid for everyone who is good at leveraging a mortgage to achieve investment income to do so). For us it doesn't come down to the money we might be forgoing by not having a mortgage--if it did, we'd still be working (look how money we're all forgoing by er'ing). We're just done with debt, any debt, even debt that might work in our favor.

 

[ShokWaveRider]

We're just done with debt, any debt, even debt that might work in our favor.

Here Here, and have been for the last 15 years!

 

[rayvt]

I'd stick with my AA. If you have a 50/50 AA why not just take the money you dollar cost average into bonds and apply it to the mortgage. You're keeping the AA if you think of the mortgage and it's return as part of your bond allocation.

It is simply incorrect to think of your mortgage as part of your bond allocation.
This is an extension of the fallacy that paying extra principal is the same thing as earning X% on that amount.

Bonds pay interest to you. Your house doesn't.

And, if you are retired and don't get a paycheck, you are not "dollar cost averaging" anything.

 

[WestLake]

More of a waste than paying rent?

Do you really expect to borrow money for free?

Or better yet, give me an amount equal to your investments and I'll make regular payments of principal to you (but no interest).

That's why I pay cash or pay it off ASAP (bought several rentals on 5 year notes, two on 7 year notes).

 

[ERD50]

Call me stupid but I really like not having a mortgage for us (I think it's just splendid for everyone who is good at leveraging a mortgage to achieve investment income to do so). For us it doesn't come down to the money we might be forgoing by not having a mortgage--if it did, we'd still be working (look how money we're all forgoing by er'ing). We're just done with debt, any debt, even debt that might work in our favor.

Well, I don't think anyone here has suggested that anyone is 'stupid' for paying off their mortgage. That would also violate Community Rules. And I hope you aren't implying that anyone did any such thing. That would be a rather round-a-bout and subtle (or maybe not so subtle?) bit of name-calling in itself.

That said, I do think that some of the reasons given for paying off a mortgage are, ...not well thought out, or maybe unsubstantiated? But as I've often said, pay-off or not is probably the least important question facing the ER or ER wanna-be. But maybe understanding that is important?

-ERD50

 

[youbet]

I've often said, pay-off or not is probably the least important question facing the ER or ER wanna-be. But maybe understanding that is important?

And that's really the bottom line. Paying off or keeping a mortgage (at competitive, current rates) is likely to not mean very much to the financial success of an early retiree. If it makes you feel good (and it clearly does for a number of the posters), pick a time when your AA makes it convenient to come up with the cash and pay off the mortgage. I did, but yawn, it was no big deal.

 

[pb4uski]

That's why I pay cash or pay it off ASAP (bought several rentals on 5 year notes, two on 7 year notes).

If it is rentals that you are talking about it seems to me that by not carrying a mortgage you are missing out on a great opportunity to use leverage to increase return. I'm talking about modest and prudent leverage, not foolishness.