Retirees are often advised to use their life savings to fund retirement living expenses and leave the home mortgage as a lien against their property. That’s because home equity has been one of the best investments for retirees, generating income through tax-free capital gains that can be accessed through a reverse mortgage. But many retirees have no debt and are self-sufficient on a small monthly budget from investment income or pensions. They might better pay off their mortgage at retirement to avoid the added interest costs.
Things to consider when you pay off your mortgage:
Consider a reverse mortgage
Some retirees who have paid off their mortgages and have limited income opt for a reverse mortgage that lets them pull out cash to supplement Social Security and pensions. Only your heirs will be responsible for the loan balance at your death, meaning that if you don’t exhaust your lifetime savings, your heirs won’t be stuck with an estate full of debt.
Consider the costs of a reverse mortgage
The fees to get a reverse mortgage are high, typically 5% to 6% of the loan balance at closing or $5,000 to $6,000 if you’re already 62. On top of that, there’s an annual 2% servicing fee. The loan is amortized over five years and then fully amortized every year after over 30 years. The loan size you can access depends on your age and life expectancy, but it’s typically capped at 70% to 80% of the home’s value. Typical interest rates range from a low of prime plus 2% to a high of prime plus 5%.
Consider downsizing to save cash
If you’re living in too-big digs, downsize and pocket some cash, then use some or all of it to pay off the mortgage. It’s often not necessary, however, to move into smaller quarters. You may find that you can get by in your home without selling by adjusting your lifestyle, dining out less, clipping coupons, and watching DVDs.
Consider other loan options
A home equity line of credit is an option if you have any equity that you want to tap. You can use the money for anything and repay it later. If you don’t need the cash, pay off the mortgage and lock in a solid rate of return. Home equity loans also let you take cash out, but interest rates are higher than for lines of credit.
Consider investments with higher returns
Investing in cash or short-term bonds is not a bad option, but there’s typically less risk if you use bonds as an alternative to a reverse mortgage. You can always liquidate the investment for a lump sum later and pay off the mortgage.
Not paying off all or part of your home loan is not necessarily a bad idea if you have another source of retirement income besides Social Security and pensions (so-called non-retirement income). That income might come from a part-time job, investments, or rental properties. You might be able to sock away enough of your non-retirement income to cover expenses and still have enough in the bank or portfolio to pay off the mortgage.
Consider seeking professional advice
A financial planner can help you decide if a reverse mortgage would be ideal. He could also suggest an investment strategy that gives you a better shot at paying off the loan, considering your age, life expectancy, and other goals, such as sending your children to college or leaving a legacy for your grandchildren.
Advantages when I pay off my mortgage
Paying off a mortgage is a great way to promote financial security. With fewer monthly expenses and your home paid off, you are less likely to have no cash reserves in an emergency.
Mortgages tend to have more favorable interest rates than other loan products. Borrowers can also deduct the interest from their taxes as an itemized deduction to receive some tax benefits for their mortgage payments.
There are also several estate planning benefits when it comes to paying a mortgage. With a reverse mortgage, the loved ones who inherit your property will receive the total value of your home, which is valuable for estate planning purposes.
Many times, homeowners who pay off their mortgages receive a tax break. Two different methods can be used to calculate the tax deduction for mortgage payments. The first method allows for a deduction of up to $1 million for the interest paid on a mortgage.
There is also a special provision for those using retirement funds to pay a mortgage. The law was changed in October 2006 so that individuals over 59 ½ can now access their retirement funds without paying the penalty.
