For some homeowners, opting for a mortgage refinance requires a simple math problem to determine how much they can save with a lower interest rate. Homeowners within a decade of retirement, though, need to take a broader look at their overall financial plan before determining how a refinance fits into their retirement scenario.
Retire with debt?
The first consideration is whether to retire with debt.
“Many people believe they should not have any debt in retirement, but it may not be a problem as long as the retirees have the capacity to make the mortgage payments,” says Rich Arzaga, founder and CEO of Cornerstone Wealth Management Inc., in San Ramon, Calif. “If their cash flow is healthy and their investments are growing enough to beat inflation, having a mortgage is not really a risk.”
Jeff Bogue, owner of Bogue Asset Management LLC in Wells, Maine, says that retirees who intend to retire with a mortgage need to be certain of a sustainable cash flow.
“I would not recommend retiring with debt unless you have a long-term stream of steady income such as a pension or a large Social Security benefit,” Bogue says. “If you are relying solely on the market to provide your retirement income you may run into more trouble because of the variables of the market. In that case, it would be better to eliminate your debt prior to retiring.”
Mortgage refinance options
Arzaga says homeowners should methodically evaluate scenarios for their retirement with and without mortgage debt before choosing whether to refinance.
“Homeowners should look at the possibility of a mortgage with lower payments for 30 years and also see if they can afford a 15-year loan to pay off the loan faster,” Arzaga says.
A 15-year loan will have higher monthly payments than a 30-year loan, but the long-term cost is significantly lower.
Arzaga says, “Refinancing makes sense as long as the homeowners will stay in the property for at least 10 years, qualify for a lower interest rate and will use the savings for retirement.”
Steve Foldes, CEO of Foldes Financial Management Inc. in Miami, suggests that refinancing needs to be evaluated on the basis of the two biggest challenges of retirement: longevity and inflation.
“Retirees need to make sure they have a well-balanced, diversified portfolio, and if a refinance can generate additional cash to invest, it can make sense,” says Foldes. “But homeowners must remember that after retirement they will need to make their mortgage payments from their investments. Increasing the amount of your portfolio to make sure you will be able to generate growth even after retirement is essential to avoid running out of money.”
Foldes advocates cash-out refinancing in some cases so that homeowners can invest their cash for retirement.
Arzaga says refinancing to get out of an ARM makes sense for pre-retirees who benefit from a fixed payment.
“Even if you refinance into a 30-year loan, you can always make accelerated payments on the mortgage after you have paid down other high-interest debt and funded your retirement account,” Arzaga says.
True cost of mortgage refinance
Bogue says that many homeowners calculate the cost of a refinance and the monthly savings to determine how quickly they can recoup their expenses.
“People should really look beyond that and realize that if they are refinancing from a mortgage on which they have 25 years left to pay into a new 30-year loan, they will be making five extra years of mortgage payments,” Bogue says. “It makes more sense to look at the current mortgage, the new mortgage and the cost to refinance along with those back-end extra payments.”
For some homeowners, particularly if they are near the end of their mortgage, Bogue recommends paying down the principal with extra payments rather than refinancing.
Tax deductions and mortgage refinance
While some homeowners want to keep a mortgage even in retirement for the tax deduction on the mortgage interest, Bogue points out that retirees usually are in a lower tax bracket, reducing the value of the deduction. In addition, near the end of a mortgage, the majority of the monthly payment goes to principal rather than interest.
Peace of mind
For some pre-retirees, paying off their mortgage either with their current loan or by refinancing into a shorter loan term means more than the numbers. As Bogue puts it, “some people just sleep better at night if they know they will retire without any debt.”