Wall Street Journal
It used to be that paying off a home mortgage was acause for celebration. Once that final payment was made,families would gather in jubilation over the accomplishmentof owning their home lock, stock, and barrel. According toa recent column by Jonathan Clements, however, all of thathas changed. Writing in the , Clementspoints out that more Americans are retiring from the workforcebefore they've been able to retire their mortgage.
As evidence, Clements cites the most recent FederalReserve Survey of Consumer Finances, which indicates that"32% of households headed by someone aged 65 to 74 werecarrying home mortgage debt as of 2001." That percentageis up from 26% just 3 years ago. Unfortunately, havingmortgage debt in your retirement years can cause significantfinancial hardships.
Clements illustrates the potential pitfalls of this practicewith two couples who recently retired at age 65. Couple A isable to live comfortably on a combination of $16,000 a yearfrom Social Security and $24,000 from their individual retirementaccounts. The combination of their income and half oftheir government benefit does not surpass the $32,000threshold where a couple filing jointly pays taxes on theirSocial Security. Therefore, that portion of their cash flow isnot taxed. Factor in the tax on their IRA withdrawals andstandard deductions and couple A is left with $39,400 inafter-tax income. Couple B is in a similar situation, except forone major difference: They're still paying out on a $200,000,30-year fixed-rate mortgage they took out at age 50. Thatmeans they're saddled with a $1200 mortgage payment everymonth, or $14,400 in annual livingexpenses beyond those of couple A.
Couldn't couple B take advantageof their mortgage tax deduction? Accordingto Clements, that won't getthem very far. Since they're already inthe 16th year of their 30-year mortgage,only $8400 of their $14,400 inannual payments goes toward interest.Adding in a modest $5000 for otherdeductions, Clements projects thatcouple B might have total itemizeddeductions of $13,400, not muchhigher than the $11,600 standarddeduction couple A can take. In addition,to meet their monthly mortgagerequirements, couple B will need tomake increased taxable withdrawalsfrom their IRA—75% more than coupleA. Those larger withdrawals willalso raise the level of their totalincome, causing them to pay taxes ontheir Social Security benefits.
Clements points out that carryingmortgage debt into your retirementcreates more than just tax problems.For starters, the large, fixed monthlyexpense reduces your flexibility whenit comes to making investment decisions.More importantly, couple B'scurrent mortgage severely limits theirability to take advantage of a reversemortgage. According to Clements,"A reverse mortgage is the financialbackstop for cash-strapped retirees." That's because a reverse mortgage allowshomeowners to leverage the equityin their home for tax-free income.However, since couple B already has aconventional mortgage and they stillowe more than $142,000 on the loan,they might not have much equity onwhich to draw.
What couple B could have done,Clements suggests, is made additionalpayments on their mortgage eachmonth as a means of paying off theloan early. For example, say couple Bhas a $200,000, 30-year fixed-ratemortgage at 6% with a $1200 monthlypayment. If they added $50 to eachmortgage payment, the loan would bepaid off in 27 years. Adding $200 eachmonth means the loan will be paid offin 21 years. And if they added $500 toeach monthly payment, they'd bemortgage-free in 15 years, when theyreach age 65.
Clements advises that the nexttime you decide to purchase a newhome or to refinance your existingone, make sure you tailor the lengthof the mortgage to your expectedretirement date. While mortgagerates are low and mortgage interestremains one of the last great taxdeductions, don't make the mistakeof carrying that burden into yourgolden years.