Do you have to pay off your mortgage before you retire? »News from Mexico

Is it a good idea to retire with a mortgage? Most people will jump through hoops to live without mortgages, regardless of whether it makes more financial sense. Of course, all things being equal, it is always better to cut spending. But in most cases, everything It is not The same: paying off a mortgage early or giving it up altogether usually comes at the expense of something else. Retiring on a mortgage is usually not a financial risk and is sometimes the best financial decision. But paying off a mortgage before retirement also has benefits. This is when it may or may not make sense to pay off a mortgage before retiring.

Do you have to pay off your mortgage before you retire?

Kristin McKenna, Darrow Wealth Management

Early repayment of the mortgage can reduce retirement costs, but it also reduces liquidity

Using extra income or savings to pay off a mortgage more quickly turns your most liquid asset (cash) into a very illiquid asset (your home). In the most extreme examples, this is known as “poor de la casa”. Since homelessness is never a target, we recommend that you consider all your resources before choosing to expedite your mortgage payments.

On the other hand, not having a retired mortgage can be beneficial if it reduces your overall lifestyle costs and how much you will have to withdraw from your retirement portfolio. Depending on the situation, this can mean being able to retire earlier or a greater chance of not running out of money. Especially in falling markets, it is important to have relatively low fixed costs, as they can prevent the forced sale to pay the bills.

However, if the goal is to pay off a mortgage before retirement, spend potential mortgage payments Other things during retirement, math may not work. For one thing, any savings from home debt for retirement are a one-time savings (interest expense). Adding new line items to a perpetual retirement budget, which increases with inflation each year, will not translate into net cost savings.

Aside from that, the money isn’t there if you want to use it for something else in retirement, like a down payment on a Snowbird condo or sending your grandchildren to college.

Don’t be afraid of leverage

Leverage is when the expected rate of return on an investment exceeds the financing costs. If you can borrow money for less than an amount that you can reasonably expect to earn by investing the funds, then it makes sense to keep the loan.

For example: A homeowner has a mortgage with an interest rate of 3%. Its long-term average expected return is 5%. They are using leverage to get a better financial result.

After a period of record mortgage rates, most smart home owners have refinanced. With an extremely low loan cost, retiring with a mortgage can be the best financial option. Especially when in the current environment of rising rates, investors can earn over 4% per annum by buying a risk-free 2-year Treasury (as of 23/09/22). So, at least for a while, investors don’t even need to pour money into volatile securities to earn a return greater than the cost of debt. The hurdle is much higher for those taking out mortgages now.

Cost of loans after tax and minimum rates

With state and local taxes (SALT) now capped at $ 10,000 and standard deductions rising to $ 25,900 for married taxpayers (plus $ 1,400 if over the age of 65), fewer taxpayers benefit from detailed deductions. Without details, most charity gifts carry no tax benefit, for example. Taking a mortgage interest tax deduction can tip the balance in favor of the listing.

It is also worth considering the after-tax cost of debt and the net return on an investment in terms of opportunity cost.

Continuing with the previous example:

  • The net cost of a 3% mortgage is 2.28% for 24% of taxpayers who detail their deductions. The cost remains at 3% for those who do not detail.
  • The after-tax return on a 5% investment is 3.8% assuming short-term capital gains in a 24% tax bracket, which increases to 4.25% using a long-term capital gains tax rate of 15%.

As illustrated above, the hurdle rate is quite low for homeowners in this situation, which means that paying off a mortgage before retirement could mean leaving money on the table. The return on the break-even investment to compare with someone with a 3% cost of borrowing is 3.53% (assuming long-term capital gains) or 3.95% for short-term capital gains (such as securities of the treasure).

So, imagine a borrower has a much higher mortgage rate, perhaps 5%. Now the calculation changes considerably. the equalize the critical rate is 5.89% and 6.58% respectively. In this case, it is probably not worth the investment risk. While this helps justify prioritizing a mortgage payment, it’s still not a breeze.

Other factors to consider before prepaying your mortgage before retirement:

  • Will you live in the house long enough to enjoy years of mortgage-free life?
  • if you can’t pay turned off your mortgage, there may be little reason to pay it down Unless you have an adjustable rate loan, paying additional mortgage payments will not change your monthly payment.
  • As the graph above illustrates, rates have recently increased significantly. But there is little reason to think that mortgage rates will remain at current levels over the long term. So, for borrowers with higher rates, future refinancing opportunities could question whether free cash flow should go towards a mortgage payment today.
  • Homeowners in the last installments of a mortgage may see a small and falling principal balance and be tempted to pay it off before retirement. Before making the final transfer, remember how loan repayment works. When a new loan is issued, the interest component of the fixed payment is much higher than the principal amount of the loan. But at the end of the loan term, this relationship is canceled and the debt service costs are only a fraction of the payment.

Emotional reasons often drive the decision to prepay a mortgage. Peace of mind can help you sleep at night (which is important!), But it won’t fund a ten-year retirement. So, before using extra cash or windfall to pay off your mortgage early, consider the value of future flexibility. After all, goals often change over time.

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