Should You Carry Your Mortgage Into Retirement?

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Should You Carry Your Mortgage Into Retirement?

The excitement of waving goodbye to your monthly mortgage payment—assuming you’ve paid it off by then—is part of the idyllic vision of retirement. Recently, there has been a change in perspective that has led many financial advisors to advise retirees to keep paying their mortgage into and beyond retirement. Your golden years will be a little bit more golden if you reinvest the money from your home equity since you’ll have an immediate source of fresh income.

There may, however, be certain disadvantages. In certain circumstances, keeping a mortgage after retirement might be a smart move, but it is by no means a universally effective way to boost retirement income.

Key Takeaways

  • By reinvesting the equity from a property, those who carry a mortgage into retirement may access a second source of income. Mortgage interest is tax deductible, which is another perk.
  • The drawback is that mortgage payment obligations are set while investment earnings might fluctuate.
  • A diversified portfolio ought to provide longer-term higher returns than residential real estate.

You Can’t Eat Your Home

You can’t eat your house, which is the fundamental tenet of home equity loans. Since your property doesn’t provide any income, unless you borrow against it, your equity is worthless. Homes often provide rates of return that are lower over the long run than properly diversified investment portfolios. Home equity may potentially hinder income, net worth growth, and general quality of life in retirement since it often makes up a significant amount of a retiree’s net worth.

If investment returns are unpredictable, holding a mortgage after retirement may be challenging. This might result in difficulties making mortgage payments or worry about carrying a significant amount of debt during a downturn in the market.

Therefore, it stands to reason that the next step would be to remove your assets from your house by getting a mortgage and investing the proceeds in securities that should exceed the after-tax cost of the mortgage, increasing your net worth in the long run and your cash flow in the near term. Additionally, assets like the majority of mutual funds and exchange-traded funds (ETFs) may be sold in pieces to cover unforeseen expenses.

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All of this sounds wonderful, but it’s not that easy: There are several factors to take into account whenever you increase your financial leverage. What are the advantages and disadvantages of this tactic, then?

Pros of Carrying a Mortgage into Retirement

Over the long run, residential real estate should underperform a properly diversified investment portfolio. Don’t let the real estate returns over the last several years deceive you. Single-digit annual rates of return have historically been the norm for residential real estate, but diversified portfolios often perform significantly better over the long term and could be fairly anticipated to do so in the future. Additionally, since mortgage interest is tax deductible, adopting this kind of leverage may be done so at a lower cost, boosting the return on investment of the assets you purchase.

Finally, a single property may be deemed fully undiversified from an investing standpoint, which is bad news if it accounts for a significant amount of your net worth. Maintaining both financial stability and mental stability requires diversification.

Cons of Carrying a Mortgage into Retirement

Despite the apparent advantages, this tactic may potentially have some negative consequences. As previously indicated, obtaining a mortgage is another example of leverage. By using this method, you essentially raise the exposure of all of your assets, including not just your home but also your other investments. Your financial situation gets much more complex and your overall risk exposure rises. Additionally, the returns on your investment will change over time. Long-lasting declines may be frightening and difficult to control.

The Tax Cuts and Jobs Act of 2017 also substantially reduced the benefit of deductibility. The amount of qualifying mortgage debt that may now be written off by taxpayers has decreased from $1 million to merely $750,000. In addition, unless they are used to purchase, construct, or significantly enhance the property underlying the borrowing, the legislation prohibits the deduction for interest paid on home equity loans and lines of credit.

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Investment Returns vs. Mortgages

Another crucial point to bear in mind is that, in contrast to mortgages, investment returns may be very changeable in the near term. It is normal to anticipate times when your portfolio may perform much worse than the cost of your mortgage. Your financial foundation might be significantly eroded as a result, endangering your capacity to make payments in the future. Your mental stability can be jeopardized by this unpredictability. If you experience fear during a market downturn, you can respond by withdrawing money from your portfolio to pay down the mortgage, depriving yourself of the advantages of an investment rebound. If this were to occur, as opposed to adding to your net worth, you would actually wind up decreasing it. It’s crucial to recognize the disturbing psychological impact of leverage.

To assess the value of this technique in your own financial circumstances, you must take into account a number of objective financial elements. This technique is by no means ideal for everyone, despite the fact that some financial consultants may provide the same advice to everyone.

Finding out your entire mortgage interest expense is crucial since it will be the obstacle that your investment portfolio must overcome in order to succeed. Your creditworthiness and tax bracket are only a few of the very straightforward variables that effect this. Of course, your overall interest cost will be cheaper the better your credit. Additionally, the greater tax advantage you get from the interest write-off, the higher your tax bracket is.

Tapping Your Home Equity During Retirement

The first thing you should do is consult with your loan officer and accountant to establish your total interest cost (net of the tax advantage), which will show you how much money must be made in investments for your portfolio to cover the mortgage’s interest rate charges. To overcome this investing barrier, you need next speak with your financial counselor, which raises a new set of questions.

It is easy to know what rate of return you want, but it is more difficult to determine if you can realistically obtain that rate of return or bear the required risk. In general, increasing your equity allocation will be necessary to beat your mortgage cost, but doing so may result in significant portfolio volatility. Since they have less time to weather market fluctuations, retirees often aren’t ready to endure such high levels of volatility. Another thing to take into account is that the majority of financial consultants base their forecasts of future returns on past averaging. Don’t just depend on return expectations, in other words.

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Finding out what proportion of your overall net worth your house represents is the last important factor to think about. This choice becomes more significant the greater portion of your net worth that your residence comprises.

This topic is scarcely worthwhile if, for instance, your net worth is $2 million and your property only accounts for $200,000 of it since the net marginal gain from this technique will have a negligible impact on your net worth. However, if your net worth is $400,000 and your house accounts for $200,000 of that amount, your financial planning will be greatly impacted by this topic. Rich people are less affected by this method and presumably find it less appealing than impoverished people do.

The Bottom Line: Should Retirees Carry a Mortgage Into Retirement?

Even if it is offered by a financial advisor, it is never a good idea to follow their advise uncritically. A number of variables affect how safe it is to keep paying your mortgage when you retire. This approach might significantly complicate your financial situation and is not guaranteed to be successful. Most significantly, leverage is a double-edged sword that might seriously harm a retiree’s finances.

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