||Ask Dr. Don
Bigger house or save for retirement?
Dear Dr. Don,
The home's current value is about $90,000. Our
home is very small but livable, although our son just moved back in
with us for at least a year, maybe more.
We earn about $107,000 a year, but have not saved
enough for retirement. We are 54 and 51 years old and would like
to retire around 60 to 62. In addition to the home equity loan payment
we are paying college tuition and related costs for our son who
is finishing junior college this year and will have at least two
to three more years to finish his bachelor's degree. Our question
is this: Should we be looking for a better, bigger home and take
on a mortgage for 15 or 20 years or should we pay off our home equity
loan here, begin serious saving for retirement and make do in our
We are not sure what the tax savings would be
if we had a bigger mortgage and don't know how to compute that.
We both will have government retirements and Social Security but
just don't know what to do about housing. Can you give us some advice
I'd lean toward making do. Although your empty
nest isn't empty anymore, it's a short-range problem that doesn't
require a long-range solution. Upsizing concentrates your investments
into a single piece of real estate and you'll take on all the risks
of that market.
One advantage of upsizing is when you're ready
to retire you should be able to sell your home and not have to pay
any federal taxes on the capital gain. IRS
Publication 523, Selling Your Home, provides greater detail
on the capital gains tax exclusion on the sale of your primary residence.
Being able to use the mortgage interest deduction
reduces the effective rate of your mortgage loan, but you're still
paying interest on the loan balance. With a $200,000, 15-year fixed
rate mortgage at 5.50 percent you'll make monthly payments of $1,634.17,
total payments of $294,150, and have total interest expense of $94,150
over the term of the mortgage. If the mortgage interest deduction
saves you about one-third of the interest expense in reduced taxes
you've still effectively spent $62,767 on interest. That's money
that could have gone toward retirement savings.
If you invested the $1,634 a month over the next eight
years at an average after-tax return on 6 percent, you'll have more
than $200,000 as a retirement nest egg with no need for another
seven years of mortgage payments.
Paying off the home equity loan gives you a return
on your money equivalent to the after-tax cost of debt on the loan.
If you use the mortgage interest deduction on your taxes your after-tax
cost of debt is the loan rate times one minus the marginal federal
income tax rate. You've reduced interest expense and rebuilt the
equity in your home.
Your goal of retiring in your early sixties doesn't
seem to be very realistic if you don't have much put aside besides
the $64,000 equity you have in your home. Savings needs to be a
It would help you to hire a fee-based financial planner
to review your retirement goals, income available to you in retirement
and your current household budget. The planner would be able to
determine if you can realistically meet your early retirement goal
and what financial commitment it would take on your part between
now and then to reach that goal. The National Association of Personal
Financial Advisors (NAPFA)
can help you find a fee-based financial planner in your area.
-- Posted: Sept. 24, 2003