Saturday, March 15, 2014

Why a Mortgage in Retirement Makes No Sense

Is retiring with a mortgage a realistic option? 

As I noted in an earlier posting, for many retirees, retirement will be a perpetual tax holiday.   If you are no longer working, you no longer need to pay Social Security and Medicare taxes.   Your Social Security may be tax-free and the taxes on your investments (if any) may be at the long-term capital gains rate (the "Romney Rate") of 15%.

And thus, as I noted in that earlier post, a couple making $44,000 in retirement has the effective income of someone working who makes $55,000 a year.

But wait, it gets better.   This same couple has a house that is "paid for" and thus has no mortgage payment to make.   They don't have to pony up $1000 a month in interest and principle payments, and thus their income is equivalent to about $67,000 a year for a poor working stiff who has to pay taxes and pay a mortgage.

"But what about that great tax deduction?" you say.  Well, what about it?   Yea, the working Joe might get a slightly larger deduction if he itemizes and has a mortgage.   But that only means that his tax bill is reduced by the marginal rate (15% for him and his wife) times the amount of interest on the mortgage.   Unless you take on a huge mortgage and stress yourself financially, you don't end up with a huge deduction.

And as I have noted time and time again in this blog, you can't deduct your way to wealth and The IRS code is NOT an investment guide!   Accountants and even financial advisers often miss this point.

And people in this tax bracket can't afford huge mortgages, and being "mortgage stressed" is no fun at all.

So my math is right.   My retired couple still comes out "about" $12,000 ahead of Joe Working Stiff who has to pay a mortgage and taxes.

But let's assume there is some wonderful deduction from a mortgage that will blow the "standard deduction" out of the water.     Does it still make sense for retirees?

Well, in the real-world example I am using here, a resounding NO.   Since they are not paying any income taxes anyway, having a "mortgage interest deduction" makes no sense at all.   They can't go lower than "zero" unless they get one of those lucrative tax credits.

And you do know the difference between a tax credit and a tax deduction, right?

Now this is not to say that you should never have a mortgage or try to pay it off early.   Whether you want to do that or not depends on how old you are, how much money you make, how much you are putting into savings, your home equity, your interest rate - and a whole slew of variables.

There are no "cookie-cutter" solutions that apply to everyone.  You have to "do the math" for your own personal situation and figure out what works.

For example, when I was in my 30's and making that vaunted "six figure salary" (which back then was a lot of money, today it is what a bus driver makes - at a unionized public school) the home mortgage interest deduction made a lot of sense.   That, along with depreciation deductions on my investment properties reduced my tax burden considerably.   And yes, that is all very legal and proper.

But today - making far less and facing retirement, it makes less sense for me to take on debt, and with a lower income, such debt is not affordable, and moreover the deductions don't really help me.   Our progressive tax system penalizes the lower classes and hands a sop to the middle class in the form of tax deductions for IRAs, 401(k)s, and home mortgage interest.

But more importantly, for me at near-retirement age, having a mortgage in retirement makes little or no sense.   In order to pay that mortgage I would have to take out more money from my IRA every year, and thus pay more taxes.  Granted, some of this might wash in terms of interest deductions.  But hey, we just "did the math" on that, right?  If you are paying no taxes in retirement, a home mortgage interest deduction is pretty worthless!  Besides, you are looking at the back-end of a 30-year mortgage, chances are most of the payment is principle anyway, so you might not even get a deduction at all, even if you were paying taxes.

And there is another factor as well:   When you retire, you have to live off a finite amount of money over time.   If your annual living expenses are too high, then you tap into that savings at a faster rate.   Having a mortgage in retirement might mean that you end up draining that savings at a faster rate, and in the end you are broke with a home that is not "paid for" and may not have much equity. 


Your home also represents an asset that is pretty safe and should appreciate slowly over time.   If you own it, you can always "downsize" to an apartment or assisted living center and use the equity in the home to live on for the remainder of your life.   It represents an asset on your balance sheet (despite what financial advisers say) that is fairly liquid.

So, how does this help you if you are facing retirement, and thanks to a recent home purchase (or a refinancing or series of refinancing) you are looking at 25 more years of mortgage payments?   Well, in part, it can't help.   You have a high personal overhead in your life, which means you are going to need a high income in retirement, and that might be problematic, particularly if you haven't saved enough or faced early retirement.

But you may have options, still.   If there is any equity in the home, you can sell it and "downsize" to something more realistic.

My parents did this, selling a $400,000 home "up North" and building a two-bedroom home in Maryland for $175,000.   The difference was money they could live on - for many years - in addition to Social Security, a small pension, and other savings.   Staying in the $400,000 home and paying the onerous property taxes, maintenance, utilities, the like, would have been ruinous.

Many people resist this, and women in particular, want to either keep the "family homestead" (read: tract house in the suburbs) or buy a vacation home with six bedrooms so "the grands" (grandchildren) can come visit.

They have this idiotic romantic notion that their children and grandchildren will go "off to grandmother's house" by sleigh every Thanksgiving, Christmas, and Spring Break, to see Grandma and Grandpa, and all stay in the house.   So they buy these monster houses based on this emotional thinking scenario, and saddle themselves with debt and a huge house that costs a ton of money to insure, pay taxes on, heat and cool, and is a pain-in-the-ass to keep clean.

And sadly (and predictably) the children and the "grands" never come to visit - or visit very rarely.   It is a lot of money to spend - and to tie up - based on some scenario that rarely plays out, if ever.   And if it did, well, it would be cheaper and easier to put the kids up in a motel or something, anyway (and they'd be happier than being trapped in their parent's house, believe me!).

But sadly, many dismiss this option out of hand, for emotional reasons.   Not only do they have this fantasy of the "grands" visiting, they view having a house of a certain size as a status symbol worthy of someone of their class.   Going to a smaller home is viewed by many as an admission of defeat - or worse, poverty.

And so, they stress themselves, cleaning empty bedrooms and baths, paying mortgages on mini-mansions, and huge heating and lighting bills - as well as tax bills.   And they burn through their retirement savings at a pretty good clip, until they run out, at which point they are screwed.  Because getting old sucks as it is.  Getting old and POOR sucks even worse!