Should You Carry a Mortgage into Retirement?

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This article neglects to discuss the impact of owning a house and the leverage effect of having a mortgage! Granted, in some areas housing values have come down. But even at a mediocre 3% increase in house value annually over a long period will result in a 6% ROI (before cost of sale) for 50% equity. And the capital gain is not taxed!! So the result is, in addition to having money in the market (by not paying off the house) you get a nice tax free capital gain on the equity!

Jim S of TX 3:49PM August 28, 2009

Mark of XX, please cite your reference regarding the quote of Buffett claiming annual equities return will be more like 5% for years to come. If he belived that he would not have moved most of his personal wealth from bonds into equities as he stated he was doing late in '08. Most reasonable, non-cave dwelling analysts are predicting 10% or better for years to come. I stand by my example and look forward to profiting from my strategy.

Gary51 of CA 1:17AM August 15, 2009

Assumptions are great for models and do little for the reality we are living in. Why? Taxes may increase, decrease,inflation or deflation happens and we all expect to live a long healty life, there is no rule of thumb for every one,do your own math.

drayk of OH 6:34AM August 14, 2009

Actually, Robert, that's not quite true. Whether you're in your first month of a 30-year mortgage, or making your final payment, you're still paying interest. It's just that because the interest is assessed only to the amount of principal that is still owed, the amount of interest that you owe goes down as the principal does. So if Mr. Smith is at the beginning of a $200,000 loan and Mr. Jones owes only $10,000 on his loan that used to be $200,000, and both have a 5% mortgage rate, then Mr. Smith's next regularly-scheduled payment is probably going to be mostly interest whereas Mr. Jones's is surely going to be mostly principal. However, that doesn't change the fact that both of them have the same opportunity to send in an extra $100 principal payment and earn exactly the same 5% return on that $100.
If you look at your mortgage's amortization table, then that final payment has a tiny amount of interest-- that's because it's only approximately (not exactly) 1/12 of whatever your mortgage rate is, applied to the very small amount of principal that is still owed in that final month. Whereas the month you take out the loan, the interest is approximately 1/12 of the mortgage rate applied to the whole whopping amount you originally borrowed. But in either case, getting rid of $1 worth of principal brings the opportunity of getting rid of the interest on whatever principal still remains.
But I agree with you that it's probably not a good idea to refinance; before I did that I'd want Gary51's confidence that I could make 10% per year over a (reasonably-defined) long term.

Mark 4:53AM August 14, 2009

Gary51, your math is correct... but you need to change your 10% to an X.
And with that in mind, it's not clear whose math you're actually criticizing. It seems, rather, that you're criticizing the assumption made by some readers here-- either stated or implied-- that X is not 10%. Is that a bad assumption? Warren Buffett, for one, has stated that X won't likely be 10% over the next few decades, but more like 5%. Whether you're right and he's wrong, or vice versa, can't be answered at this point by math; at this point you can only call your stock return rate "X". What number you put in there depends on your *assumption*-- your 10% or Buffett's 5%, or some other number?-- not on your *math*. Only after you identify your assumption can you do math. And your math is impeccable-- as long as we recognize that X may or may not = anything like 10%.
Now obviously if your assumption is wrong and Buffett's is right, then it doesn't make sense to borrow at 5.5% in order to earn 5%. On the other hand, if your assumption is right and Buffett's is wrong, then you might be onto something.
But taxes complicate it further. To take one example: assume a person at the 25% rate who doesn't have enough deductions to itemize, so gains no tax advantage from the mortgage. Paying down principal on a 5.5% loan is the same thing as generating a tax-free 5.5% return. Assume further that the person already has maxed out whatever retirement contributions are available, and so the question is whether to pay down the mortgage or invest in a taxable account. In order to generate the same return as that tax-free 5.5%, the person needs to gain a taxable return of 7.3333333%. (I.e., he/ she would earn about $7.33 on a $100 investment, and then pay about $1.83 in taxes in order to have about $5.50 remaining; the person getting rid of $100 of debt at 5.5% interest also earns exactly $5.50). Now if we replace your x=10% assumption with Buffett's x=5% assumption-- not that he's necessarily right and you're wrong, but we are talking about assumptions here-- then clearly the math favors paying off the mortgage. Especially when we consider that whatever happens to property values, the return on paying off a fixed-rate mortgage is a guaranteed return, not a variable one (i.e., whether your house goes up or down in value, the return is the separate question of how much interest is being avoided).
There are other variables, of course; my own mortgage rate (in Hong Kong) is 2.5%, and there are no taxes on capital gains, dividends, or earned interest, while the marginal income tax rate (on salary) is only 16%. So I'd plug in different numbers than you would... but we still have to use our assumptions to plug in a value for X. Calling it 10% may or may not be the way to go.

Mark 4:27AM August 14, 2009

There's something wrong with a lot of the math here by the author and the readers. Let's say I have a mortgage balance of $250,000 on a $500,000 house. I am paying 5.5% interest (-$13750) on it while earning over 10% (historical long term return on equities investments) on the $250,000 (+$25000) that I have invested in an S&P 500 index fund that i did not use to pay off the mortgage when I retired. If it is in an IRA and I did not have to pay income tax on it yet, all the better. I am also earning at least the inflation rate in capital gain on the $250,000 mortgaged + $250,000 equity (around +$10000) that I have in my house. I am also getting a tax deduction on the mortgage interest. The net is clearly substantially positive and it gets better over time due to compounding effects. Yes, recent economic conditions are counter to some of this analysis, but they won't last forever. If you believe they will, then you should be living in a cave. Historically, if you have investment income to support it, staying in your house and keeping a mortgage is clearly the right thing to do.

Gary51 of CA 12:59AM August 14, 2009

We recently refide our mortgage from 5.5% to 4.5% and took cash out to pay off a 2nd home that was mortgaged at 6.25%.
We'll be itemizing until there are "Xs" on our eyes

bolis of FL 5:30PM August 13, 2009

I see retired clients and friends with big mortgages - that monthly payment really cramps their lifestyle. Many had the idea to invest the money instead of paying off their mortgages - that their returns would be higher than the moertgage interest. Well just about all either did not have the discipline to invest or invested poorly.
I agree that paying $1 in interest to save 25 cents in taxes does not compute. Also, those of us with no mortgage interest deducton still have that old friend called the "standard deduction". That is one of the biggest loopholes in the tax law. Often one is able to time payment of deductible expenses such as real estate taxes, charitable contributions and even state estimated tax payments so you can bunch deductions in one year, and take the standard deduction the other year.
I paid off my mortgage at age 53 and never regretted it.

J. Schindler of OH 2:10PM August 13, 2009

If Greg Plechner is a Certified Finanacial Planner, he needs to retake the test because he's giving out bad advice. As the reader indicated above, he needs nearly $139,000 to net a $100,000 from his 401k in a 28% tax bracket. I would be embarrased if I were him.

Dale of IA 8:04PM August 12, 2009

Another thing she does not mention is that at retirement you have probabaly already paid off the interest in your mortgage and are now just paying principle. Refinancing is a ridiculous idea since you will just be forcing yourself to pay more interest. So keeping your money in an account that gives you a return, any return, is good. However, there is also the peace of mind of having no debt.

robert of CA 5:43PM August 12, 2009