Low interest rates have changed the game for retirees—but not always in a bad way.
Consider your mortgage. With rates having fallen so far, there may no longer be a pressing need to own your house outright before you call it quits at the office.
This may be of little comfort to millions of savers trying to eke by each month on income from bank deposits paying below 1%. But today’a low rates are a boon to those saddled with a mortgage payment at a time in life when carrying large debts has long been ill-advised.
In 1989, just 26.4% of all households were retired with a mortgage, according to data from the Federal Reserve’s Survey of Consumer Finances. That jumped to 46.5% by 2007, before receding a bit during the recession.
These stats trouble traditionalists, who view owing money on a house in retirement as heresy. After all, paying off a mortgage brings peace of mind, because you know your living expenses have been cut and that your home equity offers a sturdy safety net.
Yet clinging to a mortgage in retirement has benefits too, especially with the average 30-year fixed-rate mortgage running at just 3.5%. You might be better off keeping the mortgage and investing the money elsewhere, which amounts to borrowing at a tax-deductible 3.5% in order to start a business, invest in stocks, or purchase an income property. Over time, such investments should provide superior returns.
This new calculus assumes that you have the means to pay off your mortgage in the first place. Many folks have been downsized into retirement prematurely and may still hold a mortgage because they can’t do anything about it. But for those with a choice, the basic rule of thumb: If you expect to earn more after tax on your investments than you pay after tax on your mortgage, keep the mortgage. However, if you are a conservative investor and keep your money in bank CDs and Treasury bonds, it is probably better to pay off the housing debt.
Some factors to consider:
- Taxes If your source of cash to pay off a mortgage is a 401(k) plan or other tax-advantaged account, keep the mortgage. Taking a large distribution will trigger a tax hit and possibly push you into a higher tax bracket. It might also bump you up to a level where you’ll owe more tax on your Social Security benefits.
- Tenure If you are going to sell the house in the next few years anyway, you’ll pay off the mortgage at that time. Keep the mortgage now for added financial flexibility.
- Liability Retirement accounts generally enjoy greater protections than a home from bankruptcies and lawsuits. If you suspect trouble, keep the mortgage in order to keep your retirement savings out of harm’s way.
- Cash flow If you expect to tap your home equity for living expenses, keep the mortgage. It’s cheaper than paying off your housing debt and turning around to take out a home equity line or reverse mortgage.
- Monthly payments You need to be prepared for unforeseen issues like health problems, but also to keep paying for things like property tax and neighborhood association fees. You may also want to start giving money to family. Pay off the mortgage to avoid strain on your monthly budget and to allow you to spend the additional cash flow in a way that makes you happy.