At a minimum most working clients should pay off their home mortgages as slowly as they and their lenders can stand

At a minimum, most working clients should pay off their home mortgages as slowly as they and their lenders can stand.

Early Retirees Should Make the Most of Their Mortgages

You may discuss your clients’ mortgage, monthly payments and home equity only briefly, and perhaps enter the data into a box on their financial planning questionnaire, never to be revisited again. But ignoring this portion of a client’s financial picture could mean less flexibility, and more money going toward taxes—especially for those who would rather retire sooner than later.

Wait to Pay the Mortgage?

At a minimum, most working clients should pay off their home mortgages as slowly as they and their lenders can stand. But some homeowners may even want to consider refinancing their current home for as much as the lender will allow.

Likely candidates for refinancing will include those who want to retire early, have a significant amount of assets tied up in their home equity and pre-tax retirement accounts, and have relatively little set aside in traditional savings accounts.

Also, if clients anticipate big expenses in the future, such as home remodeling, purchase of a second home, supporting a family member, or covering unfunded higher education expenses, they may want to consider getting a new mortgage.

Some clients may be hesitant about the idea. But they should consider that interest rates are unlikely to go much lower, home valuations may never be much higher, and clients who want to retire soon may never have a more favorable credit profile than they do right now. In addition, unlike other loans, the clients may be able to deduct their interest costs, lowering the net expense of the loan even further.

And if in the future the clients have no other need for the money generated by the new mortgage, they can pay some or all of it off when they want, with little or no penalty.

If clients can’t philosophically agree to get a new mortgage with maximum amount borrowed and time, they may be comfortable just refinancing for a smaller amount and/or an extended term.

Preretirement Uses of Proceeds

While the clients are working, extra excess monthly cash flow or mortgage cash-out proceeds should first be channeled toward pretax retirement plans such as 401(k)s, especially if the clients are in the higher tax brackets. Once those options are maxed out, high-interest-rate debt (like credit cards) should be retired.

Since the purpose of the remaining money from the mortgage is to provide liquidity and security, any remaining available funds should be set aside for future emergency expenses in easily accessible low-risk investments.

Postretirement Plans

There are two age-based milestones that those who retire early (i.e., in their early- to mid-50s) should eagerly anticipate. The first is when they reach 59 ½ and can tap pre-tax retirement accounts without the 10 percent penalty that is usually applied.

The second milestone comes at 62, the first age at which most clients can initiate Social Security retirement benefit payments.

But until they reach those ages, the money from the mortgage proceeds can be a component in an income strategy designed to cover both monthly and unforeseen expenses.

Of course, clients should first support themselves with any savings held outside of pretax retirement accounts. Another option for early retirees who are over 55 is their 401(k) plan, as withdrawals from that account are taxable, but not subject to the 10 percent penalty.

Using the mortgage proceeds to cover living expenses makes the most sense when clients would have no other choice but to make withdrawals from pretax retirement accounts that would be subject to both the 10 percent penalty and higher income tax rates (i.e., in the 25-percent-or-higher federal bracket).

Once clients turn 59 ½, they can withdraw money from their IRAs without the penalty, and use the funds to cover living expenses and pay down their mortgage. The same can be said for Social Security, whether clients choose to initiate Social Security at 62, 70, or somewhere in between.

HELOC

Some clients either can’t or won’t get a new mortgage, despite having significant home equity and a relative lack of liquid cash.

Along with only making the minimum required monthly payment on their current mortgage, they also might be more receptive to a home equity line of credit (HELOC). Once established, a HELOC allows clients to tap their home equity (up to a pre-established amount), and only pay interest on the borrowed amount. 

HELOCs can be especially useful to retirees (early and otherwise). Clients who need cash to cover living expenses may be better off tapping the HELOC, rather than withdrawing money from pretax retirement accounts and paying high taxes and penalties.

But there are a few drawbacks in comparison to a traditional mortgage. First, lenders usually provide a lower borrowing limit on a HELOC than they would under a standard fixed-rate mortgage.

HELOC loans often have a floating interest rate charged on borrowed balances, and if rates rise in the future, so will the cost of your clients’ borrowing. Meanwhile, the fixed-rate mortgage’s monthly payments will be the same for the duration of the loan.

Finally, most lenders will offer your clients a 30-year mortgage. But HELOCs traditionally have a much shorter term, at the end of which the loan would have to be repaid in full, or perhaps refinanced to a home equity loan.

A Reverse Mortgage

Don’t forget that clients who are house-rich still have another way to get access to their home equity without selling their house. Once they turn 62, they can probably qualify for a reverse mortgage much more easily than getting a traditional mortgage. The proceeds are tax-free, and generally never have to be repaid as long as the homeowner lives in the house, no matter how long that occupation might last.

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