I think that we can all agree that there are a few basic necessities of life. Those necessities include water, food, air and shelter. Everyone has expenses associated with shelter whether it is rent or a mortgage. Sure your home could even be paid for, but what about the costs of property taxes, utilities and maintenance? These expenses will vary with different conditions and locations, but you can clearly see there is a ongoing housing cost for everyone.
Most of the financial planners today will advise clients that they should try to own their homes free and clear when they reach retirement age. It seems logical as it is nice to have one less expense when you are on a fixed income. With that one less monthly expense there is a lot less financial pressure to cover the costs of the basic necessities, travel or recreation. A home with no mortgage gives you a cost that remains fixed at zero while other costs may actually adjust with inflation.
There is another side to this story. Some advisors would make a case that home equity could be better used elsewhere. Taking this point of view would mean that a good financial strategy would be to actually have a mortgage while in retirement.
The Principal Financial Group conducted a suvey in 2007 which concluded that aproximately 60% of those in retirement actually did own their homes outright. The current trend is indicating that number is decreasing and will continue to decrease in the future. That really brings us to the question of should retirees really want to own their homes free and clear.
The normal housing process
Most people in their lives will follow a similar track when it comes to housing. What happens when they get to retirement will depend greatly on how well they stick to the trend.
When first starting out in adult life most people are just beginning career. They don’t have the savings or the income needed to make a home purchase. Most will start out by renting an apartment or home for shelter.
Somewhere along the rental path a person will begin to understand that all that rent could just about equal a mortgage payment for a nicer place of their own. By either saving a down payment or taking advantage of first tie home buyer programs that person will purchase their starter home by securing a mortgage against the property.
Then as the home appreciates in value and the mortgage payments pay down the balance of the mortgage, the home owner finds the equity position in the home growing. Perhaps the home owner finds their income growing due to raises or their family situation requires a move to a larger home. Whatever the reason the home owner decides to use that equity that has built in the current home to make a down payment on a larger move-up home.
At this point people will start to settle in. The family situation will stabilize with a career on track and the home equity in the current home will also begin to increase. What else should they use this equity for but to finance other projects that present themselves. Perhaps the kids are hitting college age and the equity will be used for tuition or to just clear up other debts.
What will you do after that?
You are closing in on retirement and kids are leaving the nest. By now your home equity should be fairly substantial between the effects of appreciation and debt reduction from payments. Now because of the refinance to pay for tuition or reduce debt you could still have a substantial time left before the mortgage is paid off.
To most people the thought of owning their home free and clear at this point is still appealing. It makes a certain amount of sense. After all there would be no monthly housing payment and no rent. There would only be the usual expenses including maintenance, taxes and utilities. There is a lot to be said for this when you are on a fixed income.
The thing is there are scenarios that most people just don’t anticipate. Situations change as we do not live in a stationary world. People will find themselves in trouble even when the home is paid for because property values still increase. This causes property taxes to increase. Maintenance and utility costs will also increase and before you know it even retirees that own their homes can be in trouble because of inflationary effects on other expenses.
Occasionally a home owner will use savings they have accumulated to pay off their mortgage, however this may not be the best choice. Home owners considering this option should also review the possiblility of refinancing their existing mortgage to obtain lower payments. Though many retirees do have an aversion to a mortgage while in retirement, banks don’t have any problems with qualifying them. The banks primarily consider the ability to make the payment and will have the home as collateral.
There are financial planners that do not consider the equity in ones home as a high quality asset due to the insecurity, lack of liquidity and the rate of return. So for them it does not make sense to convert good assets in the form of savings into home equity.
Your individual mortgage strategy
Really what the decision comes down to is how else could that money you would use to pay down your mortgage be put to use. Could it be invested in a way that creates a better return? What this really means is that each and every situation is different, but all options should be considered. What might initially look as the most appealing option may not really be the best option.
