By FPA member Scott M. Kahan, CFP®
Last Updated: October 25, 2010
Back in the 1950s as many Americans entered homeownership, the one common goal was to eventually pay-off the mortgage and own the house outright. Many years later, when the mortgage was paid-off people would have mortgage-burning parties where they invited friends and relatives to watch them burn the mortgage papers after making their last payment. Reaching this goal was a sign of success and represented a way to a worry free retirement.
Things started to change as the real estate explosion of the 1980s hit. With housing prices skyrocketing, homeowners often used the equity in their homes to trade up to bigger homes, fund college educations, fund home renovations, purchase new cars and so on. No longer was a home an investment to one day own free and clear — instead, it became the “family bank.” Many homeowners used the approach that you could continue to borrow against the house and eventually sell it to downsize as you neared retirement. With home prices up on average 28 percent between 1980 and 20001, why wouldn’t you think you’d be able to pay off the mortgage and then start again with a smaller retirement home — and possibly still be mortgage free? Or use the equity to buy a second retirement home?
Times Have Changed
What a perfect world! Or was it? With a run-up in real estate prices, the idea that prices could actually fall as much as they have today was a foreign concept to many. And today, many homeowners long for the day when they can pay off their mortgages, especially as they approach retirement. But just like the housing market has changed, so has the potential outlook on what the possible benefits are from continuing to hold a mortgage in retirement.
With mortgage rates at historic lows, and income tax rates most likely going up, a mortgage may actually help many people in retirement. Here are some points to consider:
- The low returns on equity, fixed income and cash will not last forever. Eventually, yields will increase and the stock market will grow again. Having the cash on hand to invest rather than tied into your house would allow to you benefit from the value that can be found in today’s markets.
- One thing that will not change would be the rate on a low interest mortgage that you lock into today for 15 or 30 years. The money that you did not use to pay off the mortgage would allow you to continue to invest, and even assuming a conservative rate of return could make this a worthwhile strategy.
- You could continue to benefit from the tax deductions you’d receive. A 4.5 percent rate on a mortgage after tax deductions could actually net out to be around three percent (or less if you are in a high tax bracket in retirement). With the likelihood that income tax rates will only continue to go up, you could actually see this net out to be even more over time.
Eventually, when rates rise and investors can get a higher yielding bond or Certificate of Deposit (CD), you will have created a win-win strategy. A low rate mortgage together with a higher yielding bond or CD could give you the income and the tax deduction that many retirees need. Just remember that even though equities and bonds offer a higher rate of return than the interest cost of a mortgage, they do carry a risk that your mortgage does not.
Unfortunately, what we are going through now feels like it will last forever. It won’t and the smart investor will see the longer term opportunities available in today’s economic environment. Of course, this strategy is not for everyone. But before you rush to pay-off the mortgage as you get near or into your retirement years, have your adviser run the numbers or consult a financial planner to see if this is a possible scenario that fits into your retirement plan. Using your house as an investment and a bank may not be such a bad idea, as long as you are cautious and realize that as with most things what goes up, will more than likely come down.
1 Based upon 2000 US Census Figures
FPA member Scott M. Kahan, CFP®, is president and founder of Financial Asset Management Corp. in New York City.
