A quick internet search on whether you should pay down your mortgage before retiring will show many articles on the merit of retiring debt free. Some posts even suggest reducing the mortgage term from 30 years to 15 years to pay down the debt aggressively.
Well, my short answer is it all depends, and I know this sounds like a cliche. But let me tell you the story of Bobby and Kathy (fictional characters) and explain my reasoning on why I say so?
Bobby and Kathy, both nearing age 70, came to meet a planner. They had recently sold their business. While running the company, they had accumulated some credit card debt and a personal loan running the business. Their house was fully paid off and worth $ 900,000. They had started drawing social security. I know you think all seems well, so what is the catch?
Well, for starters, their only source of retirement cash inflow was social security. To top it off the credit card was at zero percent till October only after which the interest rate jumped to 19%. The personal loan monthly payment was proving to be a cash flow drag in their situation. Bobby and Kathy were spending a little over budget each month, and the credit card debt was adding up.
They had a small emergency fund just enough to cover for 3-4 months of living expenses and had a tax penalty bill that showed up from nowhere recently. To make matters worse, their neighbor decided to sell via an auction, which resulted in lowering Bobby and Kathy’s property values significantly.
To sum it up, Bobby and Kathy had paid down their mortgage but found themselves in a very tight spot. They felt stuck as their house represented all of Bobby and Kathy’s net worth and wealth.
What could have been done to avoid such an unfortunate situation from occurring in the first place? For starters consulting with a professional a few years in advance would have helped them systematically plan for retirement. These are the potential areas and recommendations the planner could have made :
- Beginning the retirement planning process by assessing the current cash flow situation as well as projected future requirements keeping inflation in mind. Getting into details on both inflows and outflows would have revealed a shortfall down the years. A few options like downsizing, moving on rent, delaying retirement, increasing inflows through part-time work could have been explored to manage cash flows in retirement better. Having these conversations would have prepared the couple well for the road ahead. The clients would have benefited from learning about the critical concept of diversification and hence discouraged from putting all their eggs in the home basket. Generally speaking, primary home is considered a personal use asset and does not always provide a source of income.
- Planning on taking a home equity loan rather than a personal loan/credit card debt as the interest rates tend to be lower for a home equity line of credit than any other consumer loan. Prior, to 2019, the home equity interest was deductible and would have yielded some additional tax savings. Also, refinancing the home and lowering the monthly payment to ease the cash flow situation may have made sense at the time and enabled them to invest the difference towards retirement savings.
- Being business owners, starting a retirement account like Solo 401k / SEP-IRA/Simple IRA would have enabled the couple to save some money towards retirement. Additionally, it would have resulted in tax savings for the amount contributed. Given the market performance in the last ten years of the money saved in a retirement account may have accumulated into a sizeable sum thanks to principles of compounding and tax deferral. The funds in the retirement account could have supplemented their cash inflows and made them less reliant on Social Security for daily living expenses.
What this story illustrates is that there are no blanket applications to the rule of thumb. There are no right or wrong solutions, as every situation with a client is different. Even though conventional wisdom says that we need to pay off all debt before retirement, we need a process that considers our unique situation as there are many factors at play.
Would you like to begin the process of planning for your retirement? Give us a call to get a tailor-made plan started.