Carrying a Mortgage into Retirement: Repay or Invest?
Many people imagine their retirement years to be relaxed and stress-free
Many people imagine their retirement years to be relaxed and stress-free, as they should be. You’ll have much more time for traveling, playing golf or anything else you didn’t have time to do while focusing on your career. You’re already saving for retirement, but what about your mortgage? If your home-financing program will extend into your retirement, would it benefit you more to pay it off before you trade your pinstripe suit for a swimsuit and Hawaiian shirt? Or would holding off and investing your funds be the better financial decision? Everyone’s circumstances are different, and you should certainly seek the advice of your financial planner, accountant, mortgage professional and anyone else who may assist with your finances, but here are some basics to get you started on deciding what to do with your home loan as you head toward retirement.
Before You Decide
Before you decide whether or not to repay your mortgage prior to retirement, there are some things that need to be taken into consideration. Determine whether you’re on track for your retirement savings goals, if you have enough coverage for your insurance needs and whether you’ve established an emergency fund. Then take a look at the terms of your mortgage.
While adjustable-rate mortgages offer lower initial payments, homebuyers often plan their finances based on the assumption their mortgage payments will stay the same. A fixed-rate home loan provides a steady interest rate, and can be refinanced should rates fall dramatically. This can help you plan more accurately when you’d like to have your mortgage paid off. You’ll also need to know whether your home-financing program has a prepayment penalty so you can determine if the fees charged for paying early are worth the cost.
Two Sides to the Coin
There are many arguments for both sides of the issue. Obviously, obtaining full ownership of your home offers peace of mind and relief from monthly payments. But depending on your individual circumstances, there is money to be saved and made by paying your mortgage early or by allowing your home loan to extend into retirement.
Take note of your loan agreement’s amortization schedule. Your mortgage company disclosed up front how much you will pay over the life of your loan, and including your interest, it will likely be more than twice the purchase price of your home. Depending on how early you are willing and able to pay it off, you could save a significant amount of money.
Paying off your home loan can allow for tax flexibility in your golden years. Your marginal tax rate will be minimized, and if you own your own home, you won’t be paying taxes on that either. You likely have a tax-deferred retirement plan, and if you are taking more income to make debt payments, your tax burden will increase.
On the other hand, using money that could go toward extra mortgage payments could be contributed to your workplace retirement plan. Employers often match 50 to 100 percent of your contributions on up to 6 percent of your pay. This is essentially a guaranteed return on your investment.
Investing money is another alternative. According to market researcher Ibbotson Associates, a combination of 60 percent stocks, 30 percent bonds and 10 percent cash would earn an average of more than 8 percent per year in most 20- to 30-year periods, based on historical returns.
Other debt is also an issue. If you have additional debt, it is most likely accruing at a higher interest rate than what you are paying on your home loan. It’s much better to pay off debt with nondeductible interest before you jump ahead on your mortgage payments.
Repaying vs. Investing
In his brief titled “Should You Carry a Mortgage into Retirement?” research economist Anthony Webb of the Center for Retirement Research at Boston College discussed a few possibilities for the retired person to make the most of their finances. First, if you hold assets in taxable and tax-deferred accounts, it makes the most sense to use the taxable accounts to repay your mortgage before dipping into your 401(k) or IRA.
As illustrated in the chart, you should repay your mortgage if your after-tax return on risk-free assets such as insured cash deposits and U.S. Treasuries is less than your after-tax mortgage interest rate, and to hold off if not.
If you are considering taking the riskier route and investing your available cash in stocks instead of repaying your mortgage, you are essentially betting with borrowed money. Few people are willing to take that risk. However, Webb examined two scenarios in which households invested in a mix of stocks and bonds. Scenario 1 used 50 percent of their available cash to pay off their mortgage, and then divided the remaining half evenly between stocks and bonds. Scenario 2 did not pay off their mortgage, but instead invested 25 percent of their available cash in stocks and 75 percent in bonds. He determined that assuming the mortgage interest rate and the return on the bonds were similar, the two situations were identical. Because both scenarios had the same amount invested in stocks and Scenario 2 spent two-thirds of their return on their bonds toward their mortgage payments, they both made the same amount of money. Therefore, Scenario 2 could attain their preferred combination of risk and return and still pay off their mortgage.
Paying off Your Mortgage Made Easy
If you do decide to pay your mortgage early, a popular and easy way to do so is to include an extra sum in your monthly payment and earmark it toward reduction of your principal. By some estimates, an extra mortgage payment each year can reduce the life of a loan by six years. There are many online calculators to help you determine how much interest you can save and by how much time you can cut your loan.
Another way to pay your loan off early is to send any raises and bonuses you receive as your career advances directly to your mortgage company. If you were doing well enough without them, you won’t miss it too much when you put it to good use. Also, with your contribution to the Social Security payroll tax dropping from 6.2 to 4.2 percent for 2011, you could consider putting that extra money toward your mortgage.
Enjoy Yourself!
Of course, only you can determine what is best for you. Your financial planner and other professionals can provide expert guidance to ensure your golden years are as idyllic as you envision, but this information should put you on the right track to making an educated decision. Regardless of what you choose, enjoy your retirement. After working so hard your whole life, you deserve a break!
This article was submitted by Cornerstone Mortgage Company, a full-service mortgage banker operating more than 81 offices in Texas, Georgia, Minnesota, Oklahoma, Utah, Louisiana, Arizona, Colorado, California, Mississippi, Nevada, North Carolina, Tennessee and Washington. Corporate Office/Houston, 713.621.4663, 1177 West Loop South, Suite 200, Houston, Texas 77027.
