In this episode, podcast host and author of “Control Your Retirement Destiny”, Dana Anspach, covers Chapter 9 of the 2nd edition of the book titled, “Real Estate and Mortgages.”
Or, if you are looking for a customized plan for your retirement, visit us at sensiblemoney.com to see how we can help.
Chapter 9 – Podcast Script
Hi, this is Dana Anspach. I’m the founder and CEO of Sensible Money, a fee-only financial planning firm. I’m also the author of Control Your Retirement Destiny, a book that covers the vast array of decisions you need to make as you plan for a transition into retirement.
This podcast covers the material in Chapter 9, on real estate and mortgages.
If you like what you hear today, go to Amazon and search for Control Your Retirement Destiny. And, if you are looking for a customized plan, visit sensiblemoney.com to see how we can help.
It was about 2010, and I was having a conversation with a woman who I considered to be successful and intelligent. Suddenly she says, “Well, stocks are a much better investment than real estate, right? You’re a financial planner, so isn’t that what you tell your clients?”
I was speechless.
A good planner plans. Planning encompasses all aspects of one’s financial life, including real estate and mortgages. It would be irresponsible for a financial planner to make a statement such as “stocks are better than real estate.”
Many financially independent people that I know accumulated their wealth through real estate. On the flip side, many people I know experienced bankruptcy and foreclosure by stretching their real estate investments TOO FAR. Real estate can be a profitable investment if you know what you are doing, and a disaster if you don’t.
When nearing retirement, all aspects of your financial situation need to align toward a common goal: generating a reliable source of cash flow. That means real estate and mortgages need to be evaluated just as carefully as other items on your balance sheet.
In this podcast, I’m gonna start by talking about your home and mortgage, and address one of the most common questions, which is, “Should you pay off your mortgage before retirement?” Then we’ll talk about home equity lines of credit and how to use them in retirement. And we’ll move on to discussing investment properties, and the last thing we’ll cover will be reverse mortgages.
First, let’s talk about your home. Is it an investment? Meaning is it something you hope to make money on? Or is it a lifestyle choice - something you purchase for comfort and pleasure? Everyone has their own opinion on this. For most people, the answer lies somewhere between these two extremes.
I rarely see people buy a personal residence solely because they think they can make money on it. Most of the time other factors like location, the type of neighborhood, and other personal lifestyle preferences have a big impact on a home purchase.
Yet, when discussions about retirement start to happen, at that point, people often take a fresh look at their home as an asset.
For many of you, a portion of the value of your home will need to become a part of your retirement income plan.
If you know this ahead of time, you can put more thought into your next home purchase, how you finance it, and figure out how it fits into your plan.
When I talk about fitting a home into your plan, I am not talking only about downsizing. There are other creative ways to think about your home and where you live.
For example, you can choose a home that has ample access to public transportation, so you would not need a car on a daily basis. With services like Uber and Lyft, this option can work well today and result in a net savings over the cost of auto ownership.
You can make your home as energy-efficient as possible, and make sure it has a garden or other area conducive to growing your own food.
Another option is to rent a room in your home, or buy a home that has space that can be converted into a rental. For a large portion of my adult life I had roommates. Financially, it helped cover the mortgage. For me, of even more importance, it provided me with a built-in pet sitter. I’m a dog lover. When I traveled for work or to see family, I never had to kennel my pups. This saved me quite a bit of money over the years.
And today, online options like AirBnB or VRBO.com (which stands for “vacation rentals by owner”) allow you to rent out your home, or a room in it, on a temporary basis to travelers.
Or maybe you’re thinking about moving once you’re retired. Look for states that are tax-friendly for retirees. A simple Google search on “tax friendly states for retirees” will lead you to a few great articles that show you which states might be best.
There are many creative ways your home can contribute to your retirement plan.
One of the most common questions about a home is whether you should pay off the mortgage before retirement. When I started in the financial planning business in 1995, we were trained to tell people that they could earn a higher rate of return by investing their money rather than paying extra on the mortgage. I was 23 years old and told people what I was trained to tell them.
Today, I don’t agree with that one-size-fits-all type of advice. I think most Americans are better off paying off their mortgage by the time they retire, but, not all.
The Center for Retirement Research at Boston College has done research on this topic and has an online paper available titled, “Should You Carry a Mortgage into Retirement?” In this paper, they also conclude that most retirees are more financially secure by paying off the mortgage before retirement. The research paper rejects the argument that households can earn a higher return in stocks or other risky assets. The paper addresses the practical consideration that folks trying to manage their investments for a higher return can make poor investment choices and easily mismanage their money. Cognitive decline is real, and older Americans also fall for scams. This is something to keep in mind. The money in a paid off home is safe.
Paying off the home can also be a way to trick yourself into saving more. Let me tell you about how this worked out for Jackie and Bob, who wanted to retire early.
Each time they came in to review their plan I would explain to them that they needed to save more in order to make early retirement happen.
A year later, they would come back, and their savings had not increased. They had the income to save more, but it wasn’t happening.
Finally, I decided to try a different approach. I suggested they make extra payments on their mortgage and told them as soon as their mortgage was paid off, they could retire.
Suddenly they began making progress! Seeing the mortgage balance go down was tangible. They could measure their progress toward a goal that they wanted to achieve. Accumulating money in their investment accounts where the value would fluctuate from month to month just didn’t have the same effect for them. Soon their mortgage was paid off, and today, they are happily retired.
Now, this worked for Jackie and Bob, because they were already funding their retirement accounts, and still had extra money each month to apply to their mortgage.
Are there some groups of people who may NOT want to focus on paying down the mortgage? Yes, there are. There are four scenarios I see where it may NOT make sense to pay off the mortgage.
If you are ten years or more away from retirement and trying to decide whether to pay extra on the mortgage or put more in your 401k plan, the right answer for you may be different than the right answer for Jackie and Bob. For many high-income earners, funding extra into a tax-deductible plan like a 401k will result in a better outcome over ten years than paying extra on the mortgage.
If you are a high net worth individual, or a business owner who needs to focus on asset protection, then retaining debt may have some advantages in the event that you are sued. For high net worth folks, there is a great book called The Value of Debt, by Tom Anderson, that explains why higher net worth families may want to focus on retaining the right kind of debt rather than pay everything off.
If you are a savvy business person, for example, someone who invests in franchises, or private lending, and routinely expect returns higher than 10%, then maybe you don’t want to pay off your mortgage early.
If mortgage rates are super low, keeping the mortgage and investing elsewhere may make sense. When I originally wrote Control Your Retirement Destiny in 2012, mortgage rates were in the 2.5 – 3.5% range. I don’t recommend paying off the mortgage when the rate is that low. Once the mortgage rate goes north of 5%, then I think it makes sense to begin looking at ways to pay it down.
Now, if you don’t fit in one of these four categories, and you’re listening to this thinking you ought to run out and cash in an IRA to pay off the mortgage – wait! That is not what I am talking about.
There are big tax consequences to cashing in an IRA or retirement account. After factoring in taxes, it rarely makes sense to take a big chunk of money out of a retirement account to pay off a mortgage. On the other hand, what if you inherit money that is not an IRA? Or sell a business or other property and have cash? Then, it may make sense to use that cash to pay off the mortgage, or like Jackie and Bob, create a plan to pay extra each month.
Next, let’s talk about home equity lines of credit, which we often abbreviate as “H-E-L-O-C” or HELOC.
Unexpected expenses will come up in retirement. If you must take a large unplanned withdrawal out of an account, it may mess up your investment plan and your tax plan.
For example, say you have matched up your investments so that bonds and CDs mature in each account to match the amount of your anticipated withdrawals. But now you need an extra $25,000 to help an adult child. Where should the money come from? If the growth portion of your portfolio has done well, you may be able to liquidate some of your long-term holdings to meet this extra cash need. But what if the market is down?
In addition, what if you only have assets in tax-deferred accounts? An extra withdrawal may be taxed at a higher tax rate and cause you to pay more tax on your Social Security benefits, or may push you into an income bracket where you pay additional Medicare Part B and Part D premiums.
A standing home equity line of credit provides liquidity that may come in handy. It can provide a ready source of cash that buys you time to figure out how to fit these unexpected expenses into your plan in a strategic way.
Be careful though. A line of credit is not a piggy bank to draw from. I had one retiree who was consistently spending more than we had projected. We discussed the dangers of running out of money if the spending didn’t change. He agreed, and we reduced his portfolio withdrawals. Next time we met, he had accumulated a significant amount of debt on his home equity line.
“What happened?” I asked. Instead of taking portfolio withdrawals to fund extra spending, he had tapped into his home equity line. This was like taking money out of the left pocket instead of the right pocket. We had some more tough discussions and eventually got him on track. Home equity lines are best used as a reserve strategy, not an extra source of spending money.
When we manage portfolios for client’s we custody accounts at Charles Schwab and through Schwab’s lending relationships are able to get clients set up with lines of credit at competitive rates. There is no financial benefit to us for doing this. It is part of our job as a financial planner to assist our clients with all areas of their plan. We’ve recommended using HELOCs for auto purchases, to fund a down payment for a second property, and for many other unexpected situations that clients encounter. We don’t recommend them for routine discretionary expenses, like vacations.
Next, let’s talk about real estate as an investment.
For those looking for a steady source of retirement income, rental real estate may look like the right solution. I’ve seen too many people randomly decide the foundation of their retirement plan is going to be a portfolio of rental real estate. With no experience or training, they head out and buy a property. If they’re lucky, it works out. Many aren’t so lucky. Investing in real estate is a profession – if it is not your current profession, be careful about diving in.
Whether it’s an apartment building, duplex, residential rental, or commercial property, owning real estate means you pay expenses. You must plan for:
• Property taxes
• Repairs and upkeep
• Advertising and marketing (to get tenants)
• And legal costs (particularly, if you have to evict someone and to negotiate leases and set up LLCs)
• You also have insurance costs
In addition, you wanna plan on accounting fees. Real estate makes your tax return more complicated. I’ve watched many people who liked to do their own taxes change their mind after their first investment property.
If your career up until this point has not been related to real estate, please think twice before embarking on a real estate investment. I’ve watched people lose millions in real estate partnerships that they thought were a “sure thing”. I’ve watched people pour thousands into rental income properties that were supposed to generate cash flow and instead turned into giant money pits.
In nearly every situation that turned out poorly, the person had no experience and did not go through a rigorous learning curriculum. I’m all for real estate as an investment for those who are going to treat it with the respect that any serious profession deserves.
You may have heard that real estate takes deep pockets. There is truth to that saying. You must have enough cash set aside to get through a severe downturn. Those who do are the ones that typically end up having long term success.
If you ARE interested in getting into real estate, where do you start your education? You can find seminars all over the place. Some are decent, and some are just going to cost you thousands of dollars for a lot of pretty binders.
If I were starting out in real estate, I’d skip the seminars and instead get my hands on all of John T. Reed’s books on real estate investing. Start with How to Get Started in Real Estate Investing. His material is not full of fluff; it provides you with the nuts and bolts of what it really takes to be successful. You can buy his books through his website at johntreed.com. He has over 20 books on real estate investing as well as a web page where he ranks other so-called real estate “gurus”.
The last topic to cover today is reverse mortgages. Now wait! Don’t turn off the podcast here. It is amazing how easily people will take out a mortgage, and then as soon as you add the word “reverse” to it, they immediately dismiss the idea. Plain and simple, a reverse mortgage is a mortgage. You borrow money to be able to live in your home. That is how a mortgage works.
Do you give up the equity in your home with a reverse mortgage? No. If the value of your home is worth more than the mortgage, you keep that equity when you sell your home, or your heirs inherit it when you pass.
What if the reverse mortgage puts your home “underwater” one day, where the home value is less than the mortgage? Can they kick you out and take your other assets? No.
Reverse mortgages are non-recourse loans—The bank cannot attach your other assets or those of your heirs.
With a reverse mortgage, you own the home, not the bank. Your responsibilities are to pay the taxes and maintain the property. These are the same responsibilities you have with any mortgage.
Here are a few key things that make a reverse mortgage attractive in the right situation:
You can use a reverse mortgage to pay off an existing mortgage. You can also use it to buy a home – the reverse mortgage becomes a substitute for your down payment.
Reverse mortgage income is tax-free.
And no minimum credit score is required, and a reverse mortgage does not affect your credit score.
With a reverse mortgage, a lender can foreclose on you if you do not pay your property taxes, insurance, and repairs. I frequently see this mentioned as a caution against reverse mortgages. However, if you have a paid off home and don’t pay your property taxes, you can lose your home, so I don’t see this issue as unique to a reverse mortgage.
With a reverse mortgage, the lender also has the right to demand repayment if you don’t live in your home for 12 straight months or more. This means if you move in with relatives, or into a care facility, you need to make plans to sell the home if you don’t think you’ll be returning.
Why would a planner recommend a reverse mortgage? We think they can be useful to provide cash flow for scenarios, for example, where you would delay Social Security. They can also help manage taxes as the cashflow is tax-free. They can also be used help manage sequence risk, meaning you can set up a reverse mortgage line of credit and tap that instead of selling investments when the stock market is down.
When is a reverse mortgage a bad idea?
Well, don’t take one out if you plan on moving soon. And, if you are Medicaid eligible – be cautious – you’ll need to see how the income might impact your eligibility. If you tend to overspend, a reverse mortgage might be a bad idea too. You could blow through the money, not pay your taxes, and end up losing the home. And, I don’t recommend reverse mortgages when you have no long-term care insurance. With no insurance, you’ll want to preserve the home equity so it can potentially be used for care needs later in life.
We’ve now talked about your home as an asset. We’ve talked about your mortgage, and whether you should pay it off before retirement, and the four scenarios when you should not. We’ve discussed home equity lines of credit, or HELOCs, and how they can be used to cover unplanned expenses in retirement. And we’ve discussed investment property and the fact that investing in real estate IS a profession. The last thing we discussed was reverse mortgages and the fact that they are NOT a bad word. They are simply a financial tool, that in the right situation, can be really valuable.
For more information, see Chapter 9 in Control Your Retirement Destiny, I have mortgage calculators, links to reverse mortgage calculators, and a lot of other illustrations that will help with decisions about real estate.
Thank you for taking the time to listen today. Visit amazon.com to get a copy of the book in either electronic or hard copy format.
You can also visit sensiblemoney.com and see how a staff of experienced retirement planners can help.