Carrying a mortgage in retirement is one of the highest-impact ways to optimize your income. Conventional wisdom says that retirees should pay off their mortgages so they don’t have as high of monthly expenses. Yet, this advice could be costing you a ton of money.
Here’s why you should be carrying a mortgage in retirement:
1) Cost Benefit Analysis
The benefits of investing your money and carrying a mortgage in retirement outweighs the benefits of paying off your mortgage and not investing. The net mortgage cost is much lower than the net investment return you can expect to make in a well diversified portfolio as shown in the chart below.
Here’s a comparison example using gross numbers only:
Non-Optimizer: Let’s say you’re 57 and have a $500,000 house with a remaining mortgage balance of $100,000. You decide that you want to pay off the mortgage with $100,000 you have in an ETF that tracks the S&P 500. You want to retire early and think that paying off your house is the thing to do. You withdraw from the market and pay off the loan.
Now you hold a free-and-clear house. The money that is locked in the house isn’t really earning anything (there are some other risks too that we’ll delve into later). You no longer have the stock market investment that was earning you a 8% gross return annually.
You’re now just getting by on your $1,200 per month pension and waiting until Social Security kicks in at 62. You plan to take Social Security as early as possible because you can barely get by on your pension alone.
You’re not earning a dime in the market and feel very poor because all your capital is locked up in your house, which you’re becoming more and more disenchanted with as time goes by.
If only someone explained that carrying a mortgage in retirement is much better than paying your house off.
Optimizer: Same starting scenario as above – you’re 57 and have a $500,000 house with a remaining balance of $100,000. Because you have the mind of a financial optimizer, you decide to do a 80% equity cash-out refinance at 4% interest and invest the proceeds in a well-diversified portfolio. The bank gives you $300,000 and you immediately invest the proceeds.
You originally had $100,000 in the market which you were thinking about paying off your house but you didn’t. You now add the $300,000 to the $100,000 you already have giving you total investable capital of $400,000.
But wait, you have to now pay a mortgage, which you set for a 30-year term and the balance is $400,000 ($100,000 original balance + $300,000 cash-out). Your new monthly mortgage payment is $1910 for principal and interest only.
The $400,000 in invested capital is earning 8% gross annually, or $32,000 per year, or $2,667 per month. You’re okay if you have a down year because you’re a long-term investor. You realize that volatility is the price of market admission. But you don’t just have money in the market. You also have real estate investments and other alternative investments.
The Excel file below shows how much you would lose if you had $400,000 in your house instead of taking a cash-out refi and investing the $400,000. It assumes you pay the mortgage with the investment income each year and reinvest the surplus over 30 years.
You could have $1,029,072 more at the end of 30 years if you simply took the cash out of your home and invested the proceeds.
You can download this Excel file and put in your own assumptions to see how your specific scenario plays out. The yellow cells are input cells and the rest are calculated based on the assumptions you input.
This is also available as a Google Sheet: How Much Am I Losing…
I assumed we used the $100,000 the Optimizer had in the market to payoff the house and then immediately refinance so we could compare $400,000 head-to-head. I also didn’t care about taxes in this scenario. The Optimizer likes to buy and hold so doesn’t generate capital gains.
2) Long Term Short the Dollar
Carrying a mortgage in retirement forces you to be short the U.S. dollar over the long term. Borrowing money and paying it back at a date far into the future is the same as shorting the USD. Anytime anyone’s been short the USD in recent history has had a huge advantage, as you’re essentially selling dollars (borrowing) and buying them back at a later date (repayment). The value of the USD goes down over the long term and it will likely continue to do so given that it’s fiat currency.
This occurs due to inflation. Your dollars today are worth more than they will be in the future with almost certainty. The only way this wouldn’t happen would be in deflationary environment. And we know the Fed will do anything to keep deflation at bay.
The Fed has a dual mandate:
- Full employment
- Stabilize prices
But the Fed has a 2% inflation target. It considers stable prices to be those which increase at 2% per year. This turns into a lot over a long timeframe because of compounding.
You always want to be short the dollar long term so that you can keep inflation on your side. So far the best way to accomplish this is through borrowing long-term on real estate.
3) Liquidity Risk
What would you rather have: $400,000 stuck in a house which is nearly untouchable or $400,000 in a diversified portfolio that is highly liquid?
This is a no-brainer. Having money invested is so much better from a financial security standpoint than having it locked in a house.
What if your income takes a dive and you need cash now? You wouldn’t be able to get it if it was in the house. No lender in their right mind would let you do a cash-out refinance without some sort of income.
You’ll have access to the money if you lose your job and did a cash-out refi prior to losing it. Having access to that sort of capital may be the difference between you keeping your home and being forced to sell it. You’ll be able to get by on investment income until your Social Security kicks in. This is a huge benefit.
4) Downside Protection
You bear the risk when you have all your money in your house and the value plummets. The bank bears the risk when you have little equity in the property and the value of the house plummets.
It doesn’t just have to plummet due to a neighborhood deterioration either. What if your neighbor’s tree falls on your house? (My neighbor’s tree actually fell on my car so this does actually happen. My neighbors are awesome so it worked out well for me.) Your bank will be involved because it’s their asset. It’s not just you against an insurance company that may or may not offer a prompt payout for damaged property.
Carrying a mortgage in retirement is like an added layer of insurance against loss. Your bank is being paid for this so don’t feel bad for them.
5) Interest Deduction
One of the greatest deductions of all time: the mortgage interest deduction. Mortgage interest you pay on acquiring a residence (see limits below) is tax-deductible. I can think of no other deduction that’s as powerful as the primary residence mortgage deduction.
A married couple making $200,000 and filing jointly save $2,800 on every $10,000 they pay in mortgage interest (as of 2016 rates).
Mortgage interest is front-loaded using amortization tables so that the deduction benefits are greatest during the first few years of the loan.
This works out great for a couple who’s in their mid-50’s. Their income is likely very high because most people are still working in their mid-50’s. They’re able to deduct at a higher tax bracket during the more beneficial years of the loan – say, first 5 – 7 years. Then, as they look into retiring or making less income, the benefit of the interest deduction is reduced at a perfect time.
I highly recommend a couple who is working hard and in the 28% bracket or higher have a newer mortgage to take advantage of this deduction.
Remember, you’re paying mortgage interest but you’re earning more in the market than you’re paying in interest. So it’s almost as if you’re getting paid to take a deduction! No wonder the rich get richer.
Deduction Limits (numbers as of 2017)
- Interest on a loan for a primary residence up to $1,000,000 in value if married and $500,000 if single.
- Interest on home equity debt up to $100,000 if married and $50,000 if single.
- Refinanced debt is considered new debt or debt used to acquire a residence, not home equity.
6) Equity Build And Forced Savings
Getting a new mortgage on your home doesn’t mean that you won’t continue to build equity. You do this in two ways:
- Principal pay down
- Home value increase
You’ll continue to pay the principal down when you get a new mortgage. You just start over. And it’s not a bad thing. You have the money you pulled out of the house sitting in investments. Then each and every month you continue to pay principal in addition to interest.
And carrying a mortgage in retirement doesn’t mean your house will stop going up in value. Your home’s value is determined by what someone else is will to pay for it. Strong markets include limited supply, high income earners, good neighborhoods, low crime, good schools, etc. The person buying your home doesn’t care that you have a mortgage on it. Even if you refi at 80% of your homes value, in 10 years, your percentage equity is going to be much higher.
Flawed Thinking of Not Carrying a Mortgage In Retirement
Advisors who want you to payoff your mortgage before you retire are flawed in their thinking.
Having a paid off home might be great but what was the opportunity cost? Did you payoff your mortgage but neglect other items? Maybe mom went to the county-run nursing home instead of the nice private one. Maybe you didn’t fund your retirement plans and now have no money invested. Or, it may be as simple as you haven’t gone on vacations, building memories with loved ones.
That’s why I think you need to reevaluate how you think about your mortgage. Are you just trying to payoff your mortgage because that’s what conventional wisdom says?
Carrying a mortgage in retirement is so beneficial, it simply doesn’t make sense not to. Worried about the monthly payment? Don’t be. You’ll have extra capital when you refi. Also, you’ll always have monthly costs associated with your house. Taxes, insurance, maintenance just to name a few.