One of the never-ending debates in the finance community is should you or should you not payoff your mortgage? I’ve been hearing this debate since on fo my first real estate finance classes in college. Want to maximize your net worth? Carrying a 5% or lower fixed rate mortgage for 30 years will almost always win. Want the peace of mind of a lower monthly expense number and not owning a dollar on your house? Payoff your mortgage. There’s passionate debate on both sides with valid points.
Why am I taking a mortgage into early retirement (and why it might not be right for you)
Early Retirement Now was kind enough to write this case study for me back in January. The case study includes utilizing a free and clear house as a hedge against sequence of return risk. While I hate to disagree with the maestro himself, we’re likely going to take a mortgage into early retirement. Why would we do that?
1) Fat FIRE: Based on how the timing of our planned retirement has worked out, we will qualify as Fat FIRE with over 30x our annual living expenses saved. This is already giving us a margin of error against sequence of return risk. We have always spent $2,000 to $3,000 per month plus the cost of housing and don’t see that changing in early retirement. Related: Q1 2018 Net Worth
2) Liquidity Management: The biggest risk to our early retirement plan is liquidity and tax management. Substantially all of our investments are retirement accounts we can’t easily get to. Sinking $200,000 – $300,000 of that liquidity into a house is difficult to reverse. You can get a “2nd home” loan while still working, but try to get that same mortgage as a cash-out when you have no income. If we decide to change our mind later, we can always pay off the loan.
3) Investment Opportunities: I’ve spent my career looking at private businesses and real estate, but have carried specific limitations on my outside activities. One of the biggest opportunities from quitting in my job is making a few private business investments, both in real estate and in private businesses. You need capital to do this. You *can* make private investments through an IRA, but they come with limitations that prevent you from being directly involved in those investments. If I invest in a small business, I want the ability to provide advice and collect fees if I do real work on their behalf.
4) Never be trapped again. This may or may not be the final home. Nothing is forever and sinking substantially all our liquidity into a home could prohibit future flexibility. We’ve lived through a time when the only way to sell a house was to take a 50% discount to what you paid, thus preventing us financially from being able to move. We never want to be in that situation again. If we want to move and have a modest house, it can rent for anywhere from a small profit to small deficit with a mortgage payment. We could just be looking at some free cash flow and minimal liquidity for another home, especially when mortgages are difficult to qualify for with no income.
5) A mortgage payment matches our withdrawal plan. I’ve been fortunate to have access to a SERP (supplemental executive retirement plan) over the last couple of years, helping me defer tens of thousands of dollars in income taxes. This plan starts paying out in monthly installments over fifteen years shortly after I leave work. Ideally, the tax hit will be lower over the fifteen years than paying a high marginal rate when putting the income away. A mortgage better matches the our cash inflows and outflows in early retirement.
6) I’ll probably earn something in the future. I have enjoyed some parts of my job and there are a few skills I’ve become good at, so much so that some random work will probably fall my way. I may take direct payment or I may just ask for a donation into our Fidelity Donor Advised Fund, but it’s likely I’ll make something after ending the first stage of my career. The 30x FIRE number says we never need to, but I have to consider reality.
So what is the case for not carrying a mortgage:
1) If you’re Lean FIRE and don’t anticipate any future income, sequence of return risk is real. A 30% drop in your investments with a fixed mortgage cost will wreck a Lean FIRE plan. Karsten “aka” Big ERN is spot on about this for a tight retirement plan.
2) ACA subsidies (controversy!) This is a real consideration. I won’t go into significant detail because anyone who doesn’t understand this topic needs to visit what Justin @ Root of Good wrote about this. The short version is if you go over a certain income, you lose the premium cap inside the ACA. The income limits are generous, 400% of the poverty level. There is no asset or wealth text. That’s the law folks. For a married couple without kids, you can realize an income in the low $60,000 range and maintain what amounts to a cap on insurance cost. The more money you carry in a taxable account, the more income it kicks off and risks “falling off the cliff”. $1 in income over this limit could trigger $7,000 in additional insurance costs for us.
3) Asset protection (controversial too): With the uncertainty in healthcare and our general litigious country, asset protection is a consideration for those with wealth. In certain states, your home can be exempt from creditors while your regular brokerage account is not. If that ACA is radically changed and we once again lose coverage for pre-existing conditions, this could be a bigger consideration.
4) Peace of mind: If you enjoy the psychological benefit of a free and clear house, I will not argue with that statement. These are intimate, personal decisions and for many people, a paid off house is the pinnacle of financial success.
This is ultimately a personal choice and your choice my be different from ours and there’s completely valid arguments on both sides. Do you plan on carrying a mortgage into retirement? Why or why not? Please continue the discussion below.
Great article and sound advice. We have had similar thoughts in our own early retirement planning. We sold our primary house for our current travels, but have kept investment property and we opted to retain our mortgage. Fortunately it returns more than it costs and allows us to defer taxes. When we again have a primary residence, keeping a mortgage is something we will do, providing that rates are favorable and we have liquidity to ride out unseen situations.
I didn’t see a comment box in the post so couldn’t add it directly.
I think one of the biggest problems with retirement funds not being able to take care of older adults is the fact that they have mortgages. I am a boomer and in my parents time, it was unheard of to have a mortgage and retire. They prepaid their mortgage, as did my siblings and me. It improves monthly cash flow and helps to free up money for the ever rising cost of health care.
Sue – you’re absolutely right. There is a huge difference at 60-75 when someone is not able to work anymore and has no other alternatives than for an early retiree leaving the workforce in their 30s
I’m not carrying a mortgage into retirement because I don’t want to be forced to come up with taxable income to pay it. That income would likely push me up a bracket or two. I’ll keep my 0% dividends and 0% capital gains rate instead.
I know it’s possible to get creative and avoid these taxes via loss harvesting and whatnot, but I’d rather not get too cute with the strategy.
I completely understand that line of thought Jack. With the new tax laws, I think the 0% rate extends to almost $100,000/year for a married couple. Unfortunately the ACA’s healthcare income calculation includes capital gains and dividends.
Great points, Jack, and this is the exact same direction my wife and I are looking to take when we FIRE in 2020.
Jack – You’ve hit on the biggest concern/risk in this strategy! Leaving $200,000 to $400,000 invested generates taxable income that can be problematic in four different ways. Capital gains taxes, dividend taxes, state taxes (especially in a high standard deduction state), and exceeding the income threshold to have your healthcare premiums caped. My biggest concern is actually exceeding the income cliff under the ACA.
Nice post, and sound argument. I’ve actually just decided to take the other side of the debate (we’re aggressively paying down our mortgage now), but I completely understand your point of view. For me, it comes down to reducing expenses and the liability of a large loan in retirement. Another way to think of it- if the s*** hits the fan, we can always sell our home and downgrade/move/rent if we own it outright. We wouldn’t have the same flexibility if the LTV wasn’t favorable.
I think this will forever be a debate. One of the big deciding factors has to be the question of “Am I in my forever home?”. Today, I can answer that as a resounding “no”. When we move into our next home, we can always change that decision and payoff the mortgage.
Capital gains also come into play, once we retire the capital gains rate can be zero, so we have the option to slowly payoff the mortgage while minimizing our tax hit.
Always a great subject to stir the pot and hear some different opinions.
For us, being closer to leanFIRE, it was more a math problem than a psychological one. We retired early (mid-50’s) about a year ago and carried a 3.5% mortgage with us. The equity in the home we sold to downsize and move to our new location provided us with a great cash and investable cushion to ride out any unforeseen downturns. We were afraid to find ourselves cash poor if things went south in the markets or with the economy in general.
Most of our money is tied up in retirement accounts as well. (That was a minor tactical error entering our early retirement. Note to others…make sure you have enough saved in non-retirement accounts before you say goodbye to your job). Even when we have full access to our retirement money, I doubt we’ll pay off this low interest loan. We’ve been able to far exceed the 3.5% with our investments.
And to some degree, thanks to inflation, our fixed mortgage payment will represent a smaller % of our budget while our home continues (we hope and expect) to gain value.
Thanks for the feedback. It will be a forever debate, I can remember a family member being upset when my grandparents got a low rate, 15 year mortgage when they moved into their forever home. In their case, they viewed it as an offset to the pension income coming in and moved on.
I will also be operating on a sub 4% withdraw rate and have a ton of years ahead of me, there is opportunity cost in tying up that much capital.
We just purchased a home in Florida, 20% down with a 15 year fixed at 4%. Our current home in Louisiana is paid off and would offset the new mortgage when we sell. It will be a big decision as to whether we pay off the mortgage on the new house or keep the cash. We’re retirement fund rich and cash poor currently. I just turned 50 and we still work. We’re 18 months or so from FIRE and moving to Florida. I think we keep the 4% mortgage and put our cash to work.
I go back and forth on this topic in my own mind. I’m leaning towards keeping the mortgage, but don’t need to make a decision for the time being so am putting this one off. Thanks for things to think about. ACA considerations were new to me.