Should You Carry Your Mortgage Into Retirement?

Part of the rosy image associated with retirement is the thrill of saying goodbye to that monthly mortgage payment, assuming you’ll have paid it off by then. Lately there has been a shift in mentality which has seen many financial planners suggest that retirees continue to have a mortgage until and throughout retirement. Reinvest your money home equityand suddenly you’ll have a stream of new income, making your golden years that little bit more golden.

Well, there may be some downsides. Having a mortgage in retirement can be a good idea in some situations, but it’s certainly not a one-size-fits-all solution to augment retirement. Income.

Key points to remember

  • Taking out a mortgage in retirement allows individuals to tap into an additional income stream by reinvesting the equity in a home. The other advantage is that the mortgage interest is tax deductible.
  • In contrast, investment returns can be variable while mortgage payment requirements are fixed.
  • Over the long term, a diversified portfolio should offer higher returns than residential real estate.

You can’t eat your house

The basic concept behind taking out a home equity loan is “you can’t eat your house”. Because your residence produces no income, the equity in your home is useless unless you borrow against it. rate of return lower than those of properly diversified investment portfolios. Since home equity typically makes up a significant portion of a retiree’s income net valuethis can arguably dampen income, net worth growth, and overall quality of life in retirement.

Having a mortgage in retirement can be troublesome if investment returns are variable, leading to mortgage repayment issues or the discomfort of carrying a lot of debt during a market downturn.

So logically the next step would be to transfer your assets from your home by taking out a mortgage and investing the money in securities which should exceed the after-tax cost of the mortgage, improving long-term equity and your short-term cash flow. In addition, investments like most mutual funds and exchange-traded funds (ETFs) are easily liquidated and can be sold piecemeal to meet additional spending needs.

It all sounds great, but it’s not that simple: each time you introduce more leverage in your finances, there are many things you need to consider. So what are the pros and cons of this strategy?

Benefits of taking a mortgage in retirement

A well-diversified investment portfolio should outperform residential real estate over the long term. Don’t be fooled by real estate returns over the past decade. Residential real estate historically offers single-digit annual rates of return, while diversified portfolios tend to do much better over the long term and should reasonably continue to do so in the future. Second, interest on mortgages is tax deductiblewhich can serve to minimize the cost of using this form of leverage, by increasing the return on investment securities you buy.

Finally, from an investment perspective, a single property can be considered completely undiversified, which is bad news if it represents a substantial portion of your net worth. Diversification is essential to maintain not only financial stability, but also peace of mind.

Disadvantages of carrying a mortgage in retirement

Despite the potential benefits, this strategy can also have unpleasant side effects. As mentioned earlier, taking out a mortgage loan is another form of leverage. By using this strategy, you effectively increase your total asset exposure to include not just a home, but additional investments as well. Your total risk exposure is increased and your financial life becomes much more complicated. Also, the income you get from your investment will fluctuate. Prolonged downside swings can be scary and difficult to manage.

Moreover, the Tax Cuts and Jobs Act 2017 somewhat attenuated the benefit of deductibility. Taxpayers can now only deduct interest on $750,000 of qualified residential mortgage (down from $1 million previously). The law also suspends the deduction of interest paid on home equity loans and Lines of creditunless they are used to purchase, build or substantially improve the home securing the financing.

Returns on investment vs mortgages

Another important factor to keep in mind is that investment returns can be highly variable in the short term, whereas mortgages tend to be fixed in nature. It is reasonable to expect periods of time when your portfolio significantly underperforms the mortgage cost. In particular, this could erode your financial base and potentially jeopardize your future ability to keep up with payments. This variability could also compromise your peace of mind. If you become spooked during a market downturn, you may react by dipping into your portfolio to pay off the mortgage, depriving yourself of the benefits of an upturn in your investments. If this happens, you will end up decreasing your net worth instead of increasing it. It is important not to underestimate the disturbing psychological influence of leverage.

There are many objective financial factors you should consider to determine the merit of this strategy in your given financial situation. While some financial planners may offer the same advice across the board, this strategy is by no means appropriate for everyone.

The most important consideration is determining the total cost of your mortgage interest, as this is the hurdle your investment portfolio must overcome to be successful. Factors that affect this are very simple and include your creditworthiness and tax bracket. Of course, the better your credit, the lower your total interest charges will be. Also, the higher your tax bracket, the more tax benefits you get through interest amortization.

Leverage your home equity in retirement

The first thing you need to do is talk to your loan officer and an accountant to determine your total interest expense, net of the tax benefit, which will tell you how much your investment portfolio needs to earn to pay off your mortgage interest expense. Then you must approach your investment advisor to discuss how to overcome this barrier to investment, which leads to another set of considerations.

Knowing your desired rate of return is quite simple, but whether you can reasonably achieve that rate of return or tolerate the necessary risk is another story. Generally speaking, to beat the cost of your mortgage, it will take a larger allowance to actionswhich may involve substantial amounts of portfolio volatility. Frankly, most retirees are probably reluctant to accept such levels of volatility, especially since they have less time to weather the ups and downs of the market. Another factor to consider is that most financial advisors rely on historical averages to estimate the future performance of a portfolio. In other words, don’t rely totally on performance expectations.

Finally, the last major consideration is determining what percentage of your total equity your home represents. The more percentage of your equity your home represents, the more important this decision becomes.

For example, if your net worth is $2 million and your house is only worth $200,000 of it, this discussion is hardly worthwhile, because the net marginal gain of this strategy will affect your value very little. net. However, if your net worth is $400,000 and $200,000 comes from your home, then this discussion takes on deep significance in your financial planning. This strategy has less impact, and probably less appeal, for someone who is wealthy than for someone who is poor.

The Bottom Line: Should Retirees Take Out a Mortgage in Retirement?

It’s never a good idea to blindly accept advice, even if it comes from a financial planner. The safety of transporting a retirement mortgage depends on various factors. This strategy is not guaranteed to succeed and can significantly complicate your financial life. More importantly, leverage is a double-edged sword and could have disastrous financial consequences for a retiree.

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