“I am 58 and just purchased the home in which my wife and I plan to spend the rest of our lives. We paid points to reduce the rate on a 30-year fixed-rate mortgage to 4.75 percent.
I am feeling very insecure. The payment is affordable now, but I plan to retire in seven years and my income will drop. At that point, my property taxes will almost certainly be higher as well.
I fear that when I retire, the mortgage payment will become a major strain on my finances. I would like to get it down to about half of what it is now. What is the best way to do that? I have free assets equal to about half the loan balance.”
Your free assets make it possible to eliminate your insecurity about a payment you can’t afford. The issue is how best to use those assets.
Paying Down the Balance and Refinancing: Using your free assets to pay down the balance of your existing mortgage would shorten the term but not reduce the payment. You would have to refinance to get the payment down, which would mean replacing your 4.75 percent rate with a current market rate of at least 6 percent. That is inadvisable. You may have to give up the 4.75 percent rate when you retire, but there is no point in giving it up now.
Paying Down the Balance and Modifying the Loan: Some lenders, for a fee, will modify a loan contract. Because the rate on your mortgage is so low, it would be in the lender’s interest to have the balance paid down, even if not completely. Assuming the lender is willing, you can use your free assets to pay down the balance and then modify the contract based on the new balance. This would allow you to retain the 4.75 percent rate on half of your loan.
If you pay off half the balance and the rate and term remain the same, the payment would fall by half as well. This would give you the peace of mind you are looking for.
However, there can be no assurance that the lender will be willing or able to modify the loan. Your mortgage could be sitting in a pool of mortgages that are the collateral for a mortgage security, in which case a modification would not be possible. Without the modification, there would be little point in paying down the balance.
Furthermore, it is probably a mistake to pay off any part of a 4.75 percent debt when risk-free investments are available at yields higher than that. Repaying debt is an investment that yields the interest rate on the debt. Since you can currently buy an insured 7-year certificate of deposit (CD) yielding at least 5.25 percent, you will be better off when you retire if you buy the CD rather than pay down the mortgage balance.
Sit Tight and Invest: I would use the spare cash to buy a CD that will mature about the time you retire. At that point you take stock of the market to plan your next move. If you can continue to earn more than 4.75 percent, you remain invested. On the other hand, if rates have come down to the point where you can no longer invest at a yield above 4.75 percent, you liquidate the CD, pay down the mortgage balance and refinance it to lower the payment.
The old maxim that you should have your mortgage paid off when you retire had a lot of merit for people whose wealth was largely in their home. For people with significant amounts of financial assets, however, the maxim needs revision. What matters is not the mortgage balance alone, but the balance relative to financial assets. Retiring with a $200,000 mortgage balance and $400,000 of financial assets is preferable to retiring with no mortgage and no assets.
BUT: Note that I recommended investing in an insured asset. Don’t use the revised maxim as a license to gamble with your retirement, as a lot of market gunslingers would have you do. They would like you to do a cash-out refinance for the maximum amount possible, which they will arrange for you, and invest the proceeds in risky assets, which they will also arrange for you. They take theirs off the top, but whether it works for you depends on how well the investments do. It might work out or it might not, but if you are close to retirement, it is not a gamble I recommend.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.