Last week, we evaluated the often-asked question: “should we pay off our existing mortgage?”
As we have discussed many times, there is a long-held, ingrained belief that you can’t transition away from your income from work if you still have a mortgage.
This is simply not true. In fact, there are some strategic financial reasons to maintain a mortgage during your retirement years if all of the conditions are correct.
Before I share a few considerations surrounding mortgages after you’ve transitioned away from work, I have a few general thoughts on this limiting belief:
- The first is that being 100% debt free is not a prerequisite for a relaxing retirement.
All other things being equal, having no debt is terrific, and it’s a worthy goal. It’s a fantastic accomplishment and an extremely satisfying feeling to owe nothing to anyone!
However, having a mortgage should not prevent you transitioning away from your dependence on your paycheck if your numbers still work.
Key point of emphasis: “if your numbers still work!” (This, of course, implies that you really know your numbers.)
- It’s a widely held belief that you cannot qualify for a mortgage, or refinance an existing mortgage, once you’ve retired and have no earned income from work.
It is true that it’s more difficult today than it was before the banking/real estate crisis in 2008, but it’s certainly possible.
Banks simply need to know how you’re going to pay for your mortgage.
A letter and documentation outlining your sources of income will very likely do the trick, i.e. pension, social security, investment withdrawals, etc. Especially if you have sufficient equity in your home.
- Finally, like every other part of your financial life, carrying a mortgage into your retirement years should only be done as part of a carefully crafted, well thought out long term strategy, and not as a default position.
Reasons to Carry a Mortgage After You Stop Working
There are several situations in which carrying a mortgage can be a useful tool. Here are two important examples to think about:
Example #1 – Factors #1, #2, and #3 Are True For You: When the three factors we discussed last week hold true for you, there is nothing wrong with carrying a mortgage after you’ve stopped earning money from your work.
As a refresher, here they are again in brief form:
Liquid Money: You don’t have enough liquid money to pay off your existing mortgage, or to purchase the new property you want in full, i.e. a winter condo in Florida or Arizona to escape our awful New England winters as several of our Relaxing Retirement members have done.
By “liquid”, I’m referring to paying no penalties, interest, and/or taxes to free up the money you need to pay off the mortgage vs. keeping it.
For example, if most of your money is in IRAs, you have to pay the tax man first before you can use that money.
Interest Rate: With interest rates still as low as they are today in 2017, a very strong financial argument can be made for maintaining a low interest rate, long term fixed rate loan many years into the future.
Tax Deductibility: Because mortgage interest is potentially tax deductible, carrying a mortgage has another benefit.
The question is whether the mortgage interest is deductible for you. Mortgage interest is currently only deductible for mortgage amounts lower than $1 million. ($750,000 for mortgages initiated in 2017 and beyond).
Second, it’s only valuable to you if you are itemizing deductions on Schedule A. If you have virtually no other deductions on your tax return, and you currently file using a Standard Deduction, the interest deduction from your mortgage is not helping you (unless the interest from the mortgage throws you over the top into using Itemized).
Example #2 – Home Rich, Cash Poor, Definite Term:
A problem exists for some couples in their retirement years who have a high level of equity in their homes vs. their Retirement Bucket™ investment balances. If they stay in their existing home forever, they don’t have enough liquidity in their Retirement Bucket™ of investments to sustain their lifestyle.
They have a need to reduce monthly expenses and/or increase the size of their Retirement Bucket™ to provide the supplemental income they need.
If they don’t want to downsize their home just yet, but they know they will do so inside of ten years, a potential strategy is to strategically finance their homes to reduce monthly outlays, and at the same time, build up their Retirement Bucket™ reserves.
For example, in an environment like we have today with historically low interest rates, a couple with an existing higher interest loan may want to consider refinancing to an “interest only” or 7-10 year Adjustable Rate Mortgage.
This significantly reduces their monthly mortgage payments for the duration of time they wish to remain in their home, thus freeing up monthly cash flow. This reduces their need to draw on their Retirement Bucket™ of investments each year, thus allowing it to remain intact for a longer period of time.
These are just two examples where it may still be appropriate to have a mortgage after you’ve transitioned away from your dependence on a paycheck from work.
The key point to remember is that a mortgage is a “tool” in your retirement planning toolbox. It doesn’t work for everyone. But, it can be extremely effective for some.