> Taking the Next Step
The conventional wisdom is that you should pay off your mortgage before you retire. Yet, about 4.4 million retired homeowners still had a mortgage in 2011, according to an analysis of American Community Survey data by the Consumer Financial Protection Bureau (CFPB). More than half of them spend 30 percent or more of their income on housing and related expenses, a percentage that may be uncomfortably high even for working homeowners.1
Not having to put such a large percentage — or any percentage — of your retirement income toward a monthly mortgage payment in retirement will certainly make it easier to meet your other expenses. But is it really so bad to have a mortgage payment during retirement?
“The logic behind the rule of thumb is that your income will go down in retirement, so it would be helpful if your monthly expenses went down significantly as well,” said David Reiss, a law professor who specializes in real estate and consumer financial services at Brooklyn Law School in New York. But if your income from Social Security and a pension (if you have one), and to some extent your assets (the nest egg you plan to draw on for additional retirement income), will be sufficient to make your monthly mortgage payment and meet your other expenses in retirement, there is no real reason that you have to get rid of the mortgage, he said. The key is that keeping your mortgage during retirement should be part of a plan and not a response to a crisis.
More Homeowners are Retiring with a Mortgage
More homeowners retired with a mortgage in 2011 than a decade earlier, according to the CFPB’s analysis of U.S. census data.1 They’re less likely to have their homes paid off because they’re purchasing later in life, making smaller down payments and tapping equity for other purchases.1 In fact, 36.6 percent of homeowners ages 65 to 74 and 21.2 percent homeowners age 75 and older (some of whom may not be retired yet) had mortgages or home equity loans in 2010, according to the Federal Reserve. The median balance was $79,000 for the 65 to 74 age group, and $58,000 for the 75 and up age group.2
The CFPB points out two problems with carrying a mortgage during retirement: less accumulated net wealth and the possibility of foreclosure if retirees can’t make their mortgage payments. Foreclosure is harder to recover from when you’re older because you may not be able to return to the workforce to compensate for the loss and because you’re more likely to have health problems or cognitive impairments, the CFPB said.1
Having less accumulated net wealth is a problem, especially if most of your wealth consists of your home equity, which is less liquid than stocks, bonds and cash. Foreclosure is a serious problem if it happens to you, but the odds are slim: even in the aftermath of the housing crisis, in 2011, foreclosure rates were only 2.55 percent for homeowners 65 to 74 and 3.19 percent for homeowners 75 and older.3
Some retirement-age homeowners who haven’t paid off their mortgages undoubtedly would rather be debt free but couldn’t afford to retire their home loan sooner. But others might be putting the money that could have gone toward extra mortgage payments to a better use. (Related: Saving in Your 40s and 50s: It’s Never Too Late to Get Started)
Paying Off the Mortgage before Retirement Makes Sense for Some
“Having no mortgage payment is certainly good, and if the homeowner is likely to just blow the money anyway, it's a good choice — sort of a forced savings account that pays dividends in the form of no housing payment,” said Casey Fleming, a mortgage advisor with C2 Financial Corp. and author of “The Loan Guide: How to Get the Best Possible Mortgage”. Paying off the mortgage before retirement is a great choice for undisciplined savers who are likely to be on low fixed incomes in retirement and for people who are financially responsible but very conservative.
For many near-retirees, the decision to pay off the mortgage before retiring is more emotional than financial. One emotional component of the decision is the desire to be debt free. The other is the desire to get a safe return on investment. If you pay 4 percent interest on your mortgage balance each year, then paying off your balance is the same as earning a 4 percent annual return on an investment — not bad for a risk-free return, especially in today’s low-rate environment.
Your return from paying off your mortgage is lower if you’re still getting the full tax deduction for your mortgage interest. Say your marginal tax bracket in retirement will be 25 percent. That means your effective mortgage interest rate is 3 percent. That’s the real risk-free return you get from paying off your mortgage.
You could earn a lot more by investing in stocks, especially within a tax-advantaged retirement account such as a 401(k) or IRA. But you’d be taking on more risk.
Mortgage in Retirement: Emotional and Financial Benefits
There are also emotional reasons to not pay off the mortgage. If paying off the mortgage would mean seriously depleting your savings, you might feel more comfortable keeping that money in your bank or brokerage account than tying it up in your home.
“Paying off the mortgage at retirement is rarely beneficial,” said certified financial planner David M. Williams, director of planning services for Wealth Strategies Group in Cordova, Tennessee. Your home equity is unavailable for retirement cash flow and ultimately goes to your heirs. “Maintaining and managing a mortgage may actually improve retirement cash flow,” he said.
Doing a cash-out refinance might make sense, especially with average mortgage rates of 3.5 percent on 30-year, fixed-rate mortgages and 2.7 percent on 15-year, fixed-rate mortgages, according to mortgage-rate aggregator Bankrate.4 Depending on where you live, you may be able to get an even lower rate if you have excellent credit and are willing to shop around. Cashing out your equity gives you more money to work with in retirement. A home equity loan or line of credit would also accomplish that goal, but you’ll pay a higher interest rate: about 4 to 5 percent, according to Bankrate. Any of these loans will let you make use of your home equity instead of just living in it. If possible, apply well before you retire; many people will find it easier to qualify based on their working income than based on their retirement income and assets.
Fleming said continuing to make regular monthly mortgage payments but investing any excess income you would otherwise use to pay off your mortgage can be a good option for disciplined savers who are good at investing and for people who are uncomfortable without a lot of money in savings. The key is to invest in secure, long-term, high-yield investments that will give you a nest egg for making your mortgage payments in retirement.
These investments might include low-cost Standard & Poor’s 500 stock index funds or dividend-paying stocks from blue-chip companies: the same things you’re likely already investing in for retirement. Keep in mind, though, that all equity investments involve risk.
Getting Rid of Your Mortgage Payment in Retirement with a Reverse Mortgage
Besides doing a cash-out refinance or getting a home equity loan or line of credit, there’s another way to tap your home’s equity for retirement income: a reverse mortgage.
Some reverse mortgage lenders advertise getting rid of your monthly mortgage payment as a reason to take out a reverse mortgage. Why keep working to make your mortgage payment when you really want to retire, or retire but struggle to get by because of your mortgage payment? They present a reverse mortgage as a solution. Whether it is or not depends upon individual circumstances.
A reverse mortgage, also called a home equity conversion mortgage (HECM), turns the equity from your primary residence into a stream of monthly payments from the lender to the homeowner. The homeowner makes no payments to the lender, and the homeowner remains the home’s title holder. If the homeowner passes away, the lender sells the home to pay off the reverse mortgage. Any excess proceeds go to the homeowner’s estate, but if the amount owed is more than the home is worth, the lender has no recourse — they can’t go after you or your family for the balance. If the homeowner moves out and sells the home, the proceeds go first to toward repaying the reverse mortgage; if there is anything left, the homeowner keeps the balance.5
You must be at least 62 and have enough equity in your home to qualify for a reverse mortgage. You also must continue making property tax and homeowners insurance payments for as long as you live there (if you don’t, the lender can foreclose, just like they can with a regular mortgage). The amount of money you can receive from an HECM depends on how much your home is worth, how old you are, what interest rate you can get and what fees are associated with the loan. The more your home is worth, the older you are and the lower the interest rate and fees, the higher your proceeds. You can either get a single lump sum at closing to pay off your existing mortgage, or if your existing mortgage has a low balance, you can get a smaller lump sum to pay off your loan plus a line of credit to draw on in the future, if and when you need it. (Related: Reverse Mortgages: What You Need to Know)
Getting a reverse mortgage is an option for someone who needs to generate an income stream from their home equity, but means someone else has control of your asset and has set out the terms of how you can use it, diminishing your flexibility and liquidity, said Lisa M. LaMarche, co-founder of Milestone Wealth Advisors in Greenville, Delaware.
And a big knock on reverse mortgages is that to account for the interest that will accrue on the loan over the years plus the loan’s closing costs, the money you receive up front might only be half or less of what your home is worth.6 Reverse mortgages also limit your flexibility.
“With a reverse mortgage, your debt increases over time due to the interest on the loan,” said Jim Adkins, founder and CEO of Strategic Financial Associates, a financial planning, investment advisory, and wealth management firm in Bethesda, Maryland. “And if you change your mind or wish to move due to health reasons, proceeds from the sale of the property will go to the bank in order to pay off the reverse mortgage, leaving little or no money for yourself. Although it may seem counterintuitive, keeping a mortgage payment during retirement can potentially provide you with more freedom and flexibility in the long run.”
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1 Consumer Financial Protection Bureau, Office for Older Americans, “Snapshot of older consumers and mortgage debt,” May 2014.
2 U.S. Federal Reserve, 2010 SCF [Survey of Consumer Finances] Chartbook, July 19, 2012.
3 AARP Public Policy Institute, “Nightmare on Main Street: Older Americans and the Mortgage Market Crisis,” July 2012.
4 Bankrate.com, mortgage rates for July 7, 2016.
5 U.S. Department of Housing and Urban Development, “Frequently Asked Questions about HUD's Reverse Mortgages,” HUD.gov.
6 Bankrate.com, “Reverse mortgage to pay off 1st mortgage,” January 20, 2016.