When asked about home mortgages planners, myself included, pretty much parrot the guidelines lenders use when evaluating mortgage applications. But this ignores, perhaps foolishly, the comprehensive picture. So, I’m recalibrating my mortgage advice (and you should, too), because getting the loan approved should not be your only guideline. Think about retirement; principal and interest payments mean less money for retirement savings and vacations.
Lenders want to loan the maximum amount you can repay even if painfully. The mortgage guidelines omit two crucial pieces of life satisfaction — retirement contributions and vacations. If it comes down to an IRA contribution or the mortgage payment there’s really not a choice. All work and no play makes for a pretty dull life; families need vacations.
The specific cut-off level varies among lenders but total monthly debt service, including house payment, ranges between 35-41 percent of gross monthly income. Some FHA loans allow higher levels. Many people will find it difficult to adequately fund retirement with debt service levels this high. While home equity can be used for retirement, home prices historically underperform stocks and if you need $10,000 you can’t sell the front porch. Ideally, keep your mortgage payment, including escrow, between 25 and 30 percent of your gross income, otherwise saving for retirement could be difficult.
Advisors sometimes drop the ball when it comes to mortgage types and especially length. Fifteen year mortgages are financially better because you pay less interest and you build equity faster. Paying off a mortgage prior to retirement reduces your fixed expenses during retirement. Since returns vary, your retirement portfolio will perform better with lower fixed costs. Many asset managers, fiduciary or otherwise, dance around this reality.
Some money managers will downplay a 15-year mortgage’s benefit because income going toward the mortgage balance means fewer billable assets, but that’s short-sighted and self-serving. Someone will point out four percent mortgage rates undercut this strategy and I say baloney. Paying down a mortgage is risk-free while an investment portfolio has all types of risk. An investment portfolio has a risk premium historically around 3 to 5 percent. Then include your investment costs. Before long you top 8 percent and anyone planning their retirement with that number needs a rabbit’s foot, too.
Each family works in a unique financial environment but most people will be better served with a mortgage paid off before retirement. Today’s current low interest rate environment may challenge that quaint notion but being debt-free liberates you. Rich folk miss one of life’s great pleasures — making the last payment on a note. It’s OK to owe money by choice, not so much by necessity. For instance, refinancing a loan to improve cash flow can be a viable option even if sub-optimal.
Buy a home you can afford. Too much home can be an albatross. Strongly consider a 15-year mortgage. If you have an existing 30-year mortgage, consult with your lender to see if a bi-monthly payment can reduce your mortgage balance sooner. Unless you have a sweet pension, you don’t want a mortgage in retirement.
Land Use Changes: Thanks for all the feedback and Facebook shares. Remember Pogo’s observation, “We have met the enemy and they are us.”
Buz Livingston, CFP has a Blue Mountain Beach based fee-only, hourly financial planning and investment management firm. For more information, visit www.livingstonfinancial.net or come by his new office at 2050 Scenic 30A, M1-Unit 230, Redfish Village.