Should You Pay Off Mortgage When You Retire

Should You Pay Off Mortgage When You Retire – When someone asks for financial advice, you can guarantee that the answer will include investing in real estate and saving for retirement. Conventional wisdom: Owning a home and paying off your mortgage early are critical to achieving stability and maintaining financial health in retirement. That’s good advice! But isn’t it better to pay off the mortgage as quickly as possible?

Let’s take a closer look at this hypothesis to see if there is a better option that creates more value. In particular, we look at how retirement savings are built up before retirement, how a person can retire comfortably, and how this affects their estate planning.

Should You Pay Off Mortgage When You Retire

Age: 35 years old Location: Lives in Ottawa, Ontario Income: Gross annual income $100,000 Let’s say his salary increases at 3.00% per year. Cost: $3,000 monthly expenses excluding housing expenses (car, food, utilities, etc.). For first-time home buyers, let’s say these numbers increase by 3.50% per year

Spend Or Save: Should I Pay Off My Mortgage Or Invest For Retirement?

Real estate is up 6% per year (down from the 20-year average of 7.5%) Investments are 8.50% pre-retirement and 5.50% post-retirement due to a shift to lower-risk assets with shorter maturities.

To make the numbers easier to understand, any future value (net worth, assets, retirement costs, etc.) is calculated at present value.

That means “in today’s dollars” adjusted for inflation. Today, Pete is buying his first home and has chosen a five-year term, 25-year amortization, and a 5.50% fixed-rate mortgage.

Now that Pat has a mortgage, he can start taking advantage of his early payment advantage by putting in any extra savings each month to pay off his mortgage as quickly as possible. After the mortgage expires, it renews at a fixed interest rate and continues to make prepayments, repeating the process until the mortgage is paid off early. This is expected to happen when Pat turns 50, so he will pay off his 25-year mortgage in 15 years. Now that he owns his entire house and has no more mortgage payments, he begins putting his monthly savings into a pension fund until he retires at age 65. Here’s how Pete retired when he turned 65:

Paying Off Debt Before Retirement

* Net worth is the sum of all assets (property and investments) minus all debt (mortgage).

Unlike Scenario 1, instead of paying off the previous mortgage with additional payments, Pat pays off the regular mortgage. With extra savings each month, Pete spends. At the end of the five-year term, Pete decided to refinance to get all the equity in his home instead of renewing his mortgage.

What will he do with the extra money from the refinance? You guessed it: He’s investing for retirement. Pete repeats this process at the end of each five-year period, continuously refinancing and investing until he retires. Here’s a quick breakdown of Pete’s retirement situation:

So how does Pat get the big toe in scene 2? The difference is the strategic use of your equity. As the value of his assets increases (and his mortgage balance decreases), he releases that value at a mortgage interest rate that is less than the return on his investment. Simply put, Pete won’t benefit from saving 5.50% on his mortgage when he’s earning 8.50% on his investment, and that amount will grow over time.

Should You Pay Off Your Mortgage Or Invest For Your Retirement?

In addition to increasing his net worth, Pete diversified his assets. With $1,320,000 in liquid assets compared to $438,000, 32 percent of his net worth is invested in the home instead of 75 percent in Scenario 1.

Pete can’t pay for groceries with his home equity. Liquid assets can easily be turned into cash and are just what Pete needs to fund his retirement and cover his expenses. A heavy focus on real estate means Pete’s net worth is largely dependent on the value of his assets. If the housing market turns negative, he cannot diversify and may see his wealth decline significantly.

In Scenario 2, Pete finances the purchase of an additional $882,000 in liquid assets with a higher mortgage balance. As a result, Pat must either reduce assets or maintain a large income to pay off as large a mortgage balance as possible.

It is important to note that high mortgage loan requirements are not guaranteed. However, when people wait until retirement to take out a mortgage, their qualifying income will almost always be lower than it was before retirement, and the mortgage amount they can qualify for will also be lower.

Should You Pay Off Your Mortgage Before Retiring?

At 65, Pat is enjoying his time, sipping champagne at his retirement party and ready to retire! Let’s take a look at how Pat’s retirement life would change in each scenario.

Pete begins liquidating his liquid assets to fund his retirement. By the time he turns 80, he will have about 14 years left of his 20-year retirement. To cover the gap, Pete takes out a 9.50% reverse mortgage on his home. The money from the reverse mortgage will allow Pete to finance the rest of his retirement.

Pete began drawing down his assets to fund his retirement. He will not run out of money when he retires.

In scenario 2, Pat would have significantly more liquid assets, but they would be depleted more quickly because the mortgage payments would take up a significant portion of Pat’s cash flow. However, you can see that Pete’s assets will see him retire in scenario 2, while in scenario 1 he needs a reverse mortgage to cover it. Your liquid assets.

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Although the reverse mortgage is better than forcing Pete to sell his house, it has a mortgage interest rate of 4% higher than what he would get with a conventional mortgage. How much the stomach can produce is also limited. With a conventional mortgage, Pat can finance up to 80% of the value of his property, while with a reverse mortgage, this amount is limited to 30-55% of the value of his property, depending on the lender, his age, etc. factors. There is also no guarantee that this product will be available in the future (only a few lenders offer it), which could mean Pat is left with personal loan options. Interest rates are around 10% higher than usual. mortgage.

Borrowing at high interest rates will also begin to reduce the net worth of the property over time. In Scenario 2, you have $2,066,000 compared to Pete’s net worth at 85 of $1,520,000, which is about 36% more!

Two important factors are at play here. First, owning a home doesn’t automatically give you access to the home equity built up by paying off your mortgage or appreciating home values. Generally, you only realize the value of your property when you sell your home.

We’ve all heard the term “home equity” in conversations about home ownership, but unless you’re in the business of selling or renovating real estate, you can’t use the equity in your home. . turn on. . Once pre-approved, a refinance allows you to take full advantage of the equity in your home without having to sell it.

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When looking at investment returns, they often exceed today’s mortgage interest rates. This allows you to profit from two sources: the increase in real estate prices, as well as the return of all the funds you have invested. If you use multiple tax savings accounts, such as investing in an RRSP or TFSA, none of them are used in our model. We’ve all heard of the power of compound interest when it comes to interest rates and investment returns. This method makes your investment even stronger.

Let’s be clear: Both scenarios build retirement wealth, and home ownership is a powerful tool you can use. The traditional method also has its advantages. Many people appreciate the sense of security that comes with paying off their mortgage without having to manage it as part of their monthly budget. Conventional wisdom tells us that owning an entire home is the smart choice, and for most of us, it’s certainly the safest option. What many of us overlook is that much of the financial stability in retirement comes from investing more in your nest egg and earning more in retirement. Knowing that you won’t have enough assets to make a down payment for retirement doesn’t make sense, even if you know that a reverse mortgage is a possible option.

Disclaimer: We created a model, not a crystal ball. It doesn’t surprise us to learn that investing, especially when starting a business, can have a big impact on your financial health in retirement.

Conventional wisdom would have us think that “use” is a dirty word. We often think of refinancing your home as something that some people only do because they are in desperate need of cash.

Pay Off Mortgage Or Invest: What’s Best As You Approach Retirement?

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