Pay off the Mortgage at Retirement???

[JustCurious]

we still haven't broken the 2000 high on the SP500.

This is not true. The SP500 does not reflect dividends which have been paid. If you had remained invested and reinvested the dividends, you would be above the March 2000 level.

 

[free4now]

When you are saving for FIRE, leverage can make sense because you don't need your savings to live.

When you are retired and living off savings, then leverage is bad. The reason is fairly simple and clear: Your SWR is determined mostly by how well your portfolio will survive a bad bear market right after retiring. The leverage of a mortgage always (yes always) reduces the survivability in a bear market right after retirement. So for me, it's completely clear that a mortgage reduces the safe withdrawal rate. If you are someone who can live on less than your SWR and want to take risks for possible gains then maybe it makes sense, just don't think it's helping your safety.

In short my opinion is that if you have streams of income like a pension, then a mortgage can be useful in retirement. If you are living off savings exclusively, spending around 4%, then a mortgage is playing with fire (not FIRE).

 

[sgeeeee]

. . .When you are retired and living off savings, then leverage is bad. The reason is fairly simple and clear: Your SWR is determined mostly by how well your portfolio will survive a bad bear market right after retiring. The leverage of a mortgage always (yes always) reduces the survivability in a bear market right after retirement. . . .

This is not true. FIRECalc simulations confirm that holding a low interest, long-term mortgage increases portfolio survivability. The reason is easy to understand. After a bad bear market, a portfolio survives if it has enough dollars left to grow in the recovery that follows. The more portfolio left to grow, the greater the chance for survival. A mortgage holder will have more money left to grow since the starting portfolio was not reduced by a mortgage payoff.

You have to run your own specific numbers in FIRECalc, but historically, paying off a mortgage has often resulted in greater portfolio risk -- not less.

 

[chinaco]

I have asked myself the same question. I have a 5.25% loan with about 9 years left till payoff. We will ER in 4.5 years.

The balance on our loan will be about 40k at that time. That amount is such a small amount of our portfolio value that I do not think it matters. The question for us was whether or not to accelerate the loan payoff over the next several years.

For us it is a moot point. We are probably going to down-size the house. If we do so, we will payoff the balance of the loan from the proceeds of the sale.

The target house/lando/condo will be for less money. We will pay cash for the new place.

 

[donheff]

Sqeee - I understand what you are saying. But the psychology of holding a mortgage in retirement is interesting. Does anyone know of a retiree who has chosen to pull cash out of a paid off home to invest? Theoretically, you could sit in your paid off house for 5-10 years after ER and if things looked good you could go out and take a mortgage to pull out equity and put it in the market. Or you could downsize but take out a 90% mortgage on the new place. Probably happened in late 1999, early 2000 but I don't know anyone doing it today.

 

[youbet]

Does anyone know of a retiree who has chosen to pull cash out of a paid off home to invest?

Very interesting point Don.

My house was paid off before ER mainly because we've been in the same house for 30+ years. But, when mortgage rates were very low, just before I RE'd, I could have taken out a mortgage and invested the money. This would have yielded the same results for me as holding an existing mortgage of the same amount and duration would have had for someone else. I never even considered beginning a new mortgage on my paid-off house so I'd have a loan balance, and offsetting additional investments, during retirement.

Perhaps there is a subjective difference between continuing to hold an existing mortgage and going out and obtaining a new mortgage? But objectively, the numbers would say there is no difference, everything else being equal.

 

[kb56]

Does anyone know of a retiree who has chosen to pull cash out of a paid off home to invest?

When I refinance in 03, I decided it was a good time to put more into the market. I took an additional $30K morage out of the house.

The $30K invested in 03 now worth $27K more (good market timing). Taxes on the additional money borrowed is less the $5K (with a tax benefit of more than $1K).

This worked well for me, but most people warn against borrowing too much against the house. In my case, it was a small (percentage) gamble.

 

[Nords]

Does anyone know of a retiree who has chosen to pull cash out of a paid off home to invest?

As a matter of fact I do: "Covering a mortgage without losing your ass(ets)".

Just updated it for the 30 March distibution. Up 45% since Oct 04 inception after taxes, roughly 16% APY with reinvested dividends. I'll be 74 years old by the time this is paid off, but I've noticed that NFCU now offers a 40-year loan...

 

[sgeeeee]

Sqeee - I understand what you are saying. But the psychology of holding a mortgage in retirement is interesting. Does anyone know of a retiree who has chosen to pull cash out of a paid off home to invest? Theoretically, you could sit in your paid off house for 5-10 years after ER and if things looked good you could go out and take a mortgage to pull out equity and put it in the market. Or you could downsize but take out a 90% mortgage on the new place. Probably happened in late 1999, early 2000 but I don't know anyone doing it today.

The psychology question is really just a question of risk tolerance. Each individual investor has their own unique risk tolerance and there is not right answer to what is the "best" risk tolerance. We have had one or two posters in the past indicate that they did choose to pull cash out of a paid off house for investment reasons. That clearly seems extreme to many people. I personally have not done that, but 6 years ago (3 years prior to retirement) when I moved into my "retirement home", I looked at the mortgage rates, ran a lot of simulations and chose to assume a mortgage rather than buy the house outright. That has been a very good financial decision so far and I am comfortable with risk that comes with that mortgage. In fact, I think I would be less comfortable with the risk of owning the house outright. A lot of investors seem to ignore the fact that home ownership is not without risk.

The point I always try to make in these "pay off the mortgage debates" is simply that there is no one right answer. Whether you are talking about optimizing return, optimizing SWR, or optimizing risk . . . each specific situation will yield different results. Anyone who claims "it is always better financialy to do X", or "risk is always reduced by doing y", or "SWR will always improve by doing z" , is not correct.

Furthermore, even if you analyze your specific situation and find that for you, the optimum financial decision is X . . . if you don't feel comfortable with X then it's the wrong decision. We do this kind of thing all the time with our investments. Anyone who spends time looking at historical returns data knows that for 25 year or longer horizons an investor would have historically been better off with a 100% stock portfolio -- no bonds. Some small minority of investors actually are comfortable in this knowledge and go 100% stock. But most - even those with 30+ year horizons and a clear understanding of the historical record - decide to eliminate some volatility and invest in some bonds.

When investors choose to buy bonds for personal volatility risk tolerance reasons, they usually say so without trying to claim that it is the only reasonable financial decision anyone could ever make. But for some reason, when the debate turns to mortgage payoff, a large number of investors seem to feel that they have to rationalize the decision they made to be the "best" and "only reasonable" financial decision.

 

[wabmester]

My point here, and I think it may be new, is that if a 4% SWR is the right SWR, then paying off the mortgage makes sense. It gives you more spending money, by a significant margin.

Oh boy.

CFB has tried to make this SWR / cash flow point a few times before. I'm sure he's chomping at the bit right now.

I'll just point you to one of the discussions:

link

 

[Bikerdude]

Another point to consider is that the $750/mo is $9,000 more a year you need to live on. Now if this amount comes from a deferred plan, IRA, 401K, you will pay taxes on it.

If you are collecting SS this extra 9K COULD cause more of your SS to be taxed. The limit for "other" income for SS taxation is 25K single and 32K married I believe. After those points more and more of your SS is taxed. So not having that 9K mortgage payment could save you substantial $$ on your taxes once you start SS.

Add to that strategic use of a ROTH IRA and you can dodge/delay even more taxes.

Each person has to do the numbers to see the impact for their situation.

 

[sgeeeee]

Another point to consider is that the $750/mo is $9,000 more a year you need to live on. Now if this amount comes from a deferred plan, IRA, 401K, you will pay taxes on it.

If you are collecting SS this extra 9K COULD cause more of your SS to be taxed. The limit for "other" income for SS taxation is 25K single and 32K married I believe. After those points more and more of your SS is taxed. So not having that 9K mortgage payment could save you substantial $$ on your taxes once you start SS.

Add to that strategic use of a ROTH IRA and you can dodge/delay even more taxes.

Each person has to do the numbers to see the impact for their situation.

While this is a theoretical possibility, I have never met anyone whose tax situation was actually affected adversely because they kept their mortgage in retirement. Depending on your personal situation, the tax advantages of holding a mortgage can be real.

Like you say, every person needs to check the numbers for their situation.

 

[free4now]

The leverage of a mortgage always (yes always) reduces the survivability in a bear market right after retirement.

This is not true. FIRECalc simulations confirm that holding a low interest, long-term mortgage increases portfolio survivability. The reason is easy to understand. After a bad bear market, a portfolio survives if it has enough dollars left to grow in the recovery that follows. The more portfolio left to grow, the greater the chance for survival.

I maintain that someone who takes a mortgage out and invests the proceeds at least partially in the stock market will end up worse off while living off their savings in a down market.

Of course I agree that the leverage will help them when the market turns around and starts going up, but by then the damage of the down market has been done.

I simulated a mortgage in FIRECalc and it made survivability worse. I started from the default values in Standard FIREcalc, and assumed a $100k loan, 6.25% interest only for 30 years, meaning payments of $520/mo, or 6240/year. To simulate the mortgage in FIREcalc I increased the spending from $30k/yr to $36,240/yr, and increased the assets invested from 750k to 850k.

Simulating the mortgage this way in FIRECalc dropped the success rate from 94.3% to 91.5%.

sgeeeee, if you have an example of how a mortgage can increase the FIREcalc success rate I would like to see it. It would have to be for someone with no income streams besides interest from savings invested mostly in equities, since I agree that mortgages can help if there are income streams in place.

 

[cute fuzzy bunny]

When you apply the 4% rule to your mortgage consideration you are implicitly assuming a number of things.

geez you know what? I started reading this thread and thought "Isnt it nice that SG and I can sit back and not need to participate in these mortgage threads anymore?"

Guess not.

Do some thread searches. I've quite specifically outlined how you can retire earlier, make and spend more money in retirement without a mortgage.

The secret is, as usual, in not compartmentalizing the decision or trying to place unnecessary value judgments on some aspect of the decision in order to color it towards the outcome you desire.

Got a 4% mortgage? Keep it. Early in your accumulation phase with a high tax burden that the interest deduction helps? Keep it.

Otherwise you're creating a set of problems and then desperately trying to resolve them by keeping a mortgage.

You have a smaller withdrawal rate without one, you can keep a higher equity percentage in your portfolio because you can handle the volatility better, your tax load is smaller due to the lower withdrawal rate, and you can ALWAYS take a mortgage or tap into home equity whenever you want to.

Except for rare instances, there arent many good cases for keeping a mortgage, especially in retirement.

Which is why most people dont.

 

[jdw_fire]

I simulated a mortgage in FIRECalc and it made survivability worse. I started from the default values in Standard FIREcalc, and assumed a $100k loan, 6.25% interest only for 30 years, meaning payments of $520/mo, or 6240/year. To simulate the mortgage in FIREcalc I increased the spending from $30k/yr to $36,240/yr, and increased the assets invested from 750k to 850k.

Simulating the mortgage this way in FIRECalc dropped the success rate from 94.3% to 91.5%.

Even though I agree with paying off your mortgage when/before you retire, when you use FIRECalc to look at this problem you need to use the Advanced version and put the mortgage in as a non-inflation adjusted increase to your withdrawal of $6240/yr. When you do this the success rate for the having a mortgage example is 96.2% instead of the 94.3% success without a mortgage.

 

[Spanky]

When I refinance in 03, I decided it was a good time to put more into the market. I took an additional $30K morage out of the house.

The $30K invested in 03 now worth $27K more (good market timing). Taxes on the additional money borrowed is less the $5K (with a tax benefit of more than $1K).

This worked well for me, but most people warn against borrowing too much against the house. In my case, it was a small (percentage) gamble.

You should have taken more with that kind of return.

 

[wabmester]

Even though I agree with paying off your mortgage when/before you retire, when you use FIRECalc to look at this problem you need to use the Advanced version and put the mortgage in as a non-inflation adjusted increase to your withdrawal of $6240/yr. When you do this the success rate for the having a mortgage example is 96.2% instead of the 94.3% success without a mortgage.

Excellent! I'm happy to see somebody finally tried to model this correctly. But, part of that mortgage payment still comes back to you as equity build-up, so I still think you need an amortization schedule built-in to FIREcalc to really model this accurately. (And tax modeling, too.)

So, why do you still think it's a good idea to pay off the mortgage?

 

[Hillbilly]

No mortgage here. I want to keep my expenses in retirement to a minimum. In theory this might not be the smart thing, but it sure feels good.

Same for me and here is why I paid the house off early:

1. I believe a house the most important asset one can own. A roof over one's head is a must. If I'm six feet under one day, the DW has a place to live without issues.
2. Paying the house off early (ie saving interest payments) was a "bird in the hand". Investing in stocks may not be.
3. I had one person to work for at the office (the boss). The second was the mortgage company. By getting rid of the mortgage company, I eliminated another person (boss). Only one left to go since I past FI this year!
4. Having a place to rest my head at night allowed me to concentrate on other areas such as investing, buying and selling assets (ie equipment), etc.

Would I go and borrow money from a paid for house? No way. If I need to touch my house for money, I need to get my (ass)et off the internet and get a job!

All of this is IMO. Each will have to review their situation for a best plan. Good luck.

Hillbilly

 

[sgeeeee]

I maintain that someone who takes a mortgage out and invests the proceeds at least partially in the stock market will end up worse off while living off their savings in a down market.

It depends on many factors. If you maintain that this is true for all cases, then you are wrong.

I simulated a mortgage in FIRECalc and it made survivability worse. I started from the default values in Standard FIREcalc, and assumed a $100k loan, 6.25% interest only for 30 years, meaning payments of $520/mo, or 6240/year. To simulate the mortgage in FIREcalc I increased the spending from $30k/yr to $36,240/yr, and increased the assets invested from 750k to 850k.

Simulating the mortgage this way in FIRECalc dropped the success rate from 94.3% to 91.5%.

That seems reasonable although I question whether you checked the no inflation box for the mortgage payments. So, to the extent that you got everything right in the simulator, you found a case that favors mortgage payoff. You should think about what that result means -- that the worst cases in history slightly favored payoff of a 6.25%, 30 year mortgage that represented about 13% of the total portfolio value.

sgeeeee, if you have an example of how a mortgage can increase the FIREcalc success rate I would like to see it. It would have to be for someone with no income streams besides interest from savings invested mostly in equities, since I agree that mortgages can help if there are income streams in place.

Oh god. . . Look in the archives. I must have run a dozen cases a few years ago. If I remember correctly, 6.25% was about the cross-over mortgage rate for long (over 2 decade) mortgages. For rates below that, the historical record favored keeping the mortgage. For rates above that, it favored payoff. I ran simulations to look at tax impact, rebalancing the portfolio to consider the mortgage as a bond, . . .

There is a lot of resistance from some people to the idea that keeping a mortgage can be beneficial to both portfolio performance and risk reduction. But depending on the numbers, it has certainly had that effect historically. This conclusion really shouldn't be that surprising. If I could get a 0%, 30 year loan for a hundred thousand dollars, I would be a fool not to take it. At 1%, the loan is still a no-brainer. 2%? . . . Historically, FIRECalc can tell us when the loan risk begins to adversely affect SWR. Of course, none of us can predict whether a particular mortgage will benefit us in the future. We can only compare to the past 130 years.

 

[chinaco]

I maintain that someone who takes a mortgage out and invests the proceeds at least partially in the stock market will end up worse off while living off their savings in a down market.

It is called leverage. Borrowing to invest in the stock market is monitored by the SEC. When people do it with their mortgage, it doesn't show up on the radar screen. Leverage is the reason so many people went broke in the market crash in 1929.

Bottom line... It magnifies gains and losses.

Leverage is not neccesarily a bad thing... if used properly. But it is probably not a good idea for the average investor with retirement as the goal. This is just a risk reward trade-off. What ever the underlying investment is... the risk is magnified proportionately. You can accomplish the same thing by investing directly in riskier assets and not risk the loss of your house...

 

[Hillbilly]

It is called leverage. Borrowing to invest in the stock market is monitored by the SEC. When people do it with their mortgage, it doesn't show up on the radar screen. Leverage is the reason so many people went broke in the market crash in 1929.

Bottom line... It magnifies gains and losses.

Leverage is not neccesarily a bad thing... if used properly. But it is probably not a good idea for the average investor with retirement as the goal. This is just a risk reward trade-off. What ever the underlying investment is... the risk is magnified proportionately. You can accomplish the same thing by investing directly in riskier assets and not risk the loss of your house...

Well put!

 

[al_bundy]

you should also look at the long term history of the Dow going back to 1895 or so. There have been long stretches where it has stayed flat for 20 years or so. The peak of 1929 wasn't reached again until 1955 and there was an almost 20 year stretch from approximately 1966 through 1982 where it stayed flat.

what if come 2020 we are still somewhere around the 10000-12000 level?

 

[Nords]

you should also look at the long term history of the Dow going back to 1895 or so. There have been long stretches where it has stayed flat for 20 years or so. The peak of 1929 wasn't reached again until 1955 and there was an almost 20 year stretch from approximately 1966 through 1982 where it stayed flat.
what if come 2020 we are still somewhere around the 10000-12000 level?

Yes, but consider what happened in the 10 years before or the 10 years after those grim periods. That's the nice thing about 30-year mortgages... almost as nice as 40-year mortgages!

 

[al_bundy]

that's assuming you invest before the big runup. what if you had taken out a mortgage in 2003 and invested it all then and it's essentially flat until 2020? too much risk since if the value of your home falls and the Dow does one of it's scheduled 20% to 50% crashes and stays down for a long time and you have to sell your home for some reason than you could be in a world of hurt. what if you need a large chunk of that money for some reason while the market is crashing? if it was in equity you can always borrow it. if it's invested and currently a loss you have to wait and pray

 

[Nords]

that's assuming you invest before the big runup. what if you had taken out a mortgage in 2003 and invested it all then and it's essentially flat until 2020? too much risk since if the value of your home falls and the Dow does one of it's scheduled 20% to 50% crashes and stays down for a long time and you have to sell your home for some reason than you could be in a world of hurt. what if you need a large chunk of that money for some reason while the market is crashing? if it was in equity you can always borrow it. if it's invested and currently a loss you have to wait and pray

You're preachin' to the choir, Al. Spouse and I built our portfolio from 1982-2002 and spent the last two years of that project wondering if we'd have to start all over again. We'd paid off several mortgages over the years and were actually debt free 1998-2000. BTDT.

The best advice I can give you is that all these questions have been discussed in previous threads that should be read. Pay attention to SG's posts because he's good at explaining probability, statistics, and the interpretation of the math. Look at the mitigating/safety factors I applied to our decision and, if you can't apply the same factors, then don't try this at your own home.

The simplistic answer is that a 30-year mortgage almost always gives you enough time to recover from a bear market-- especially when so many stock-market databases ignore the effect of reinvested dividends. If you're focused on that "almost" word then it brings the discussion to the same level as fallout shelters, MREs, shotgun shells, and random asteroid strikes. I can't reassure you. If you don't feel comfortable with a mortgage then don't do it.

I'm focused on the measures that can be taken to raise one's FIRECalc success rates and to minimize the risks. Going through your scary scenarios without a mortgage is worse than going through them with a mortgage, and the FIRECalc math validates that counter-intuitive concept. Paying a fixed mortgage with declining dollars is wonderful, especially if you can collect a COLA pension or annuity. Putting the money in low-cost, reinvested index funds for three decades with a small-cap value premium just loads the dice in our favor.

But that's good enough for me. When I'm in Vegas I only play blackjack, too. You have to find your own comfort zone.