Should you take your mortgage into retirement?

Part of the rosy picture of retirement is the thrill of saying goodbye to that monthly mortgage payment — assuming you’ve paid it off by then. Recently, there has been a shift in thinking that has led many financial planners to suggest that retirees continue to carry a mortgage during and throughout their retirement years. Reinvest the money from your equity and suddenly you have a stream of new income, making your golden years a little more golden.

Well, there may be some drawbacks. Carrying a mortgage on retirement may be a good idea in certain situations, but it is certainly not a one-size-fits-all solution to increasing retirement income.

Key learning points

  • Carrying a mortgage on retirement allows individuals to tap into an additional income stream by reinvesting a home’s equity. The other advantage is that mortgage interest deduction is tax deductible.
  • On the downside, the investment return can be variable, while the mortgage payment requirements are fixed.
  • In the long run, a diversified portfolio should provide higher returns than residential real estate.

You can’t eat your house

The basic concept behind taking out a home equity loan is “you can’t eat your house”. Because your home does not bring in any income, equity is useless unless you borrow against it. Historically, over the long term, homes have offered returns that are lower than well-diversified investment portfolios. Because equity is typically a significant portion of a retiree’s net worth, it can arguably be a drag on income, capital growth, and overall quality of life after retirement.

Carrying a mortgage during retirement can be tricky when investment returns are variable, leading to problems paying a mortgage or uneasiness associated with carrying a large amount of debt during a market downturn.

So, logically, the next step would be to move your equity away from your home by taking out a mortgage and investing the money in securities that should outperform the after-tax cost of the mortgage, increasing wealth in the long run. term and your cash flow in the short term. In addition, investments like most mutual funds and exchange-traded funds (ETF) can be easily liquidated and sold piecemeal to meet additional spending needs.

This all sounds great, but it’s not that simple: Every time you introduce more leverage into your finances, there are many things to consider. So, what are the pros and cons of this strategy?

Benefits of Carrying a Mortgage Until Retirement

A well-diversified investment portfolio should outperform residential real estate over the long term. Don’t be fooled by real estate returns over the past ten years. Residential real estate has historically offered single-digit annual returns, while diversified portfolios generally outperform over the long term and can reasonably be expected to continue to do so in the future. Second, interest on mortgages is tax-deductible, which can serve to minimize the cost of using this form of leverage, increasing the return on investment from the securities you buy.

Finally, from an investment standpoint, a single property can be considered completely undistributed, which is bad news if it makes up a significant portion of your assets. Diversification is essential for maintaining not only financial stability, but also peace of mind.

Disadvantages of Carrying a Mortgage Until Retirement

Despite the potential benefits, this strategy can also have some unpleasant side effects. As mentioned earlier, taking out a mortgage is another form of leverage. By using this strategy, you effectively increase your total asset exposure to include not only a home but also the additional investments. Your overall risk exposure increases and your financial life becomes much more complicated. In addition, the income you get from your investment fluctuates. Prolonged downward swings can be frightening and difficult to control.

In addition, the Tax Reductions and Jobs Act of 2017 somewhat softened the deduction benefit. Taxpayers are now only allowed to deduct interest on $750,000 on qualified home mortgage loans (was $1 million). The law also suspends the deduction for interest paid on mortgages and lines of credit, unless they are used to buy, build or significantly improve the home to secure financing.

Investment Returns vs. Mortgages

Another important factor to keep in mind is that short-term investment returns can be highly variable, while mortgages tend to be fixed in nature. It’s reasonable to expect periods when your portfolio will significantly underperform the mortgage cost. In particular, this can erode your financial foundation and potentially jeopardize your future ability to keep track of payments. This variability can also compromise your peace of mind. If you are shocked during a downturn in the market, you can respond by tapping into your portfolio to pay off the mortgage, denying yourself the benefits of a recovery in your investments. If this happens, you would end up detracting from your wealth instead of increasing it. It is important not to underestimate the disturbing psychological impact of leverage.

There are many objective financial factors to consider to determine the value of this strategy in your given financial situation. While some financial planners offer the same advice across the board, this strategy isn’t for everyone.

The most important consideration is determining what your total mortgage interest costs will be, as this is the hurdle your investment portfolio must overcome in order to be successful. The factors that affect this are very simple and include your creditworthiness and tax bracket. Of course, the better your credit, the lower your total interest costs will be. In addition, the higher your tax bracket, the more tax benefit you get from the interest depreciation.

Tapping Your Equity During Retirement

The first thing you need to do is talk to your loan officer and accountant to determine your total interest expense — after deducting the tax break — who will tell you how much your investment portfolio needs to earn to cover the interest expense on your mortgage. Next, you should approach your investment advisor to discuss how to overcome this investment hurdle, leading to a different set of considerations.

It’s easy enough to know your desired return, but whether you can reasonably achieve that return or tolerate the necessary risk is another story. In general, beating your mortgage costs will require a larger allocation to stocks, which can lead to significant portfolio volatility. Frankly, most retirees are probably unwilling to accept such levels of volatility, especially since they have less time to weather the ups and downs of the market. Another factor to consider is that most financial advisors rely on historical averages to estimate a portfolio’s future returns. In other words, don’t rely entirely on return expectations.

Finally, the last important consideration is determining the percentage of your total assets that your home represents. The greater the percentage of your assets that your home represents, the more important this decision becomes.

For example, if your net worth is $2 million and your house is only $200,000, this discussion is hardly worth having as the net marginal gain from this strategy will minimally affect your net worth. However, if your net worth is $400,000 and $200,000 of this comes from your home, then this discussion takes on profound meaning in your financial planning. This strategy has less impact, and probably less appeal, for someone who is rich than for someone who is poor.

The Bottom Line: Should Retirees Bring A Mortgage To Retire?

It is never a good idea to blindly accept advice, even if it comes from the mouth of a financial planner. The security of transferring a mortgage into retirement depends on several factors. This strategy is not guaranteed to be successful and can significantly complicate your financial life. Most importantly, leverage is a double-edged sword and can have serious financial implications for a retiree.