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Stern Advice: Should you retire with a mortgage?
May 2, 2012 / 5:46 PM / 5 years ago

Stern Advice: Should you retire with a mortgage?

WASHINGTON (Reuters) - Pay off the house before you retire. That’s the conventional wisdom, and there’s some evidence that people are following it.

Older families aggressively rid themselves of mortgages between 2007 and 2009, according to Federal Reserve data. Some 45.5 percent of households headed by people between 65 and 74 had mortgages in 2007; by 2009, only 41.6 of the same households held home loans. Only 15.1 percent of households headed by people over 75 (in 2007) still had mortgages in 2009.

That data is complex and could cover a lot of different situations: mortgages being paid down as people age, borrowers losing homes during the housing crisis, and more. But it does point to a disinclination by retirement-age people to hold mortgages.

The question is: Are they - and the conventional wisdom - right? The answer: Maybe not.

With mortgage rates still skirting historic lows, the “pay-it-off-before-retirement” argument is less compelling. It may even make more sense to keep that mortgage as long as you possibly can.

Pre-retirees who aren’t sure how to handle their mortgages should consider a lot of factors, including their tax situation, what else they might do with the money, and how long they think they will stay in their house.

Here are some ways to approach that calculation:

-- Holding a long-term fixed-rate mortgage is like selling a bond. It helps you hedge against inflation and interest rate increases. It changes your investment asset allocation, says David Hultstrom, a Woodstock, Georgia, financial adviser. So, if you have a retirement portfolio with $600,000 in stocks and $400,000 in bonds, and you have a $200,000 mortgage, your asset mix is really 75 percent stocks/25 percent bonds. Paying off the mortgage, without changing the asset allocation on your investments, would make your overall approach more conservative.

-- What does your future cash flow look like? A traditional fixed-rate mortgage is far cheaper than a reverse mortgage. If you think you’re going to want to live on some of your home equity in the early years of your retirement, you are better off stretching out the mortgage. Once you pay it off, you’d be faced with more expensive alternatives, like home equity lines and reverse mortgages, if you then decided you wanted to take money out.

-- What else would you do with the money? If you keep your $200,000 mortgage and plow $200,000 into stocks, that’s no different than investing on margin, financial adviser Michael Kitces argued in an article, “Housing: A Potentially Active Player in client Wealth Strategies” published in the April issue of the Journal of Financial Planning. And that’s something most investors would be reluctant to do.

But many other advisers quoted in the same piece said they would tell their clients to do just that: Over decades, stocks tend to return roughly 10 percent annually, according to Ibbotson Associates data. Why pull money from the market to pay off a fixed-rate mortgage charging less than half that in interest?

-- How well do you sleep at night? If you are a safety player who worries about paying bills and you keep large sums of money in the bank, you may be better off paying off your mortgage with those bank account proceeds. If you’re getting 0.8 percent on your bank savings and paying 4 percent on your mortgage, it will be like bumping up your return by an additional 3.2 percentage points.

-- Taxes are a big part of this equation. If the only cash you have to pay down your mortgage with is your 401(k) or tax-deferred individual retirement account, don’t do it, says Hultstrom. You’ll have to pay income taxes on those withdrawals, and it may even bump you into a higher tax bracket.

You may still have to make taxable withdrawals every month to make your regular mortgage payment, but that slow approach still allows you to enjoy tax deferral on most of your investments.

Note, also, that withdrawals from a tax-deferred account can also bump your taxable income up to a level where a greater percentage of your Social Security benefit becomes taxable. (When your income, calculated by a special Internal Revenue Service formula, tops $34,000 for an individual or $44,000 for a couple filing jointly, as much as 85 percent of your benefits are taxable.)

-- Might you get sued? Or go bankrupt? Every state has its own bankruptcy rules, but there are federal rules that protect retirement accounts, too. As a result, they often have greater protections than houses. If you think you’re vulnerable to losing everything, you may want to keep your money in your retirement account and not use it to pay off your mortgage.

-- How long will you stay? If you expect to sell your home and move within five years or so, the mortgage payoff decision matters less. You’ll pay it off anyway when you sell your home, so letting it ride until then could offer you greater flexibility without too much cost.

The Stern Advice column appears weekly, and at additional times as warranted. Linda Stern can be reached at linda.stern@thomsonreuters.com; She tweets at www.twitter.com/lindastern.; Read more of her work at blogs.reuters.com/linda-stern; Editing by Gunna Dickson

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