Posted on 15 December 2009
By Mark Miller
Should you carry a mortgage into retirement?
Before the economic crash last year, financial planners advised many pre-retirement and retired investors to invest any free cash in stocks, rather than pay down a mortgage. But the new economy has ushered in much more conservative attitudes about retirement planning–especially indebtedness.
Many planners now advise clients to focus on debt reduction as one of the best retirement security “investments” you can make. In retirement, you’ll likely be on a fixed income and face pressure to keep pace with rising costs, and debt-related interest expense just adds to the challenge.
The no-brainers to focus on include credit card debt and auto loans. But if you’re a homeowner, a mortgage likely is your most significant monthly debt-related expense. Let’s look at the issues to consider in deciding whether a mortgage pay off is right for you near–or in–retirement:
Where’s the best return? If you have a dollar to invest, consider whether your best return will come from investing it, or reducing the balance on an interest-bearing mortgage. If your mortgage rate’s after-tax rate is five percent, you’d need to do better than that in the stock market to be in positive territory. Historically, stocks have returned eight to 10 percent a year over 30-year periods–but it’s returned about zero over the past 10 years, and the market’s short-term direction is anyone’s guess.
Most important, stocks shouldn’t be a big part of a retirement portfolio, so the appropriate comparison is a more conservative fixed-income investment, such as certificates of deposit, Treasury Bills or Treasury bonds. Right now, a one-year CD returns about 1.45 percent.
Mortgage interest tax break: Many homeowners like the idea of keeping a mortgage for the tax deduction on interest costs. But that benefit applies to taxpayers who itemize beyond the standard deduction. And the greatest interest expense comes in the earlier years of a mortgage; with an older mortgage, the payment is mainly principal, reducing the value of any tax deduction.
The under water dilemma: Many pre-retirement baby boomers took on higher mortgage debt in the years running up to the real estate crash; a study this year by the Center for Economic and Policy Research found that 30 percent of Americans age 45 to 54 are “underwater” on their mortgages–that is, their debt is higher than their homes’ current value, and they would need to bring cash to a closing in the case of a sale.
For some, that raises a question about paying off mortgage debt that won’t provide a return when the property ultimately is sold. Indeed, University of Arizona law professor Brent T. White even suggested in a recent research paper that the rational economic move for some underwater homeowners would be to default on their loans and give their homes back to the bank.
Since that raises more moral and legal issues than most people can stomach, the best advice is to simply look at your home as housing, not an investment. In that context, owning your property debt free is more efficient than carrying a loan.
Funding a pay-down: If you have sufficient savings to pay off your mortgage without raiding emergency savings funds, use lower-return taxable savings before tapping tax-advantaged IRA or 401(k) accounts.
If you don’t have adequate cash to jettison the mortgage, refinancing to a lower rate may help you accelerate payments. Or, consider getting a part-time job and devoting your earnings entirely to accelerated mortgage payments.
Another option to consider: Sell your current home and move to an area–or home–with a lower cost of living that can be financed mortgage-free. “That can be one of the best ways to extricate yourself from mortgage debt,” says Christine Fahlund, a senior financial planner at T. Rowe Price.