Stop Paying Your Mortgage?

Steve McDonald By Steve McDonald
Bond Strategist, The Oxford Club

Two-Minute Retirement Solution

When I was learning the art of naval aviation, I rented a small place in Pensacola, Florida, from a guy named Bill Howell. Mr. Howell was retired and had spent his working years on the finance and management side of several large oil companies.

And he was a real money whiz long before TV was littered with them.

When I told him I would be staying in Pensacola for several years after I completed my training, he insisted I stop renting and buy a house. He sat me down, and – on a single piece of paper – he laid out all the calculations of why renting was a bad idea and why I had to own.

Thirty-five years later, I still have that sheet of paper.

Mr. Howell lost a tenant but gained a friend for life. He was a hell of guy!

The figures on that page look so basic now… just interest and tax deduction numbers. But back then, it was pure magic.

“I pay about the same monthly amount, build value (equity) and deduct the interest?” I asked.

I liked this ownership idea, and I bought a house that month.

Most of you remember mortgage rates when they were in the double digits, so the mortgage deduction was significant.

Mr. Howell emphasized that as long as home prices were increasing, it made a lot of sense to carry a mortgage and take the deduction.

But things have changed.

The deduction thinking doesn’t work anymore… at least not in retirement.

Contrary to what Mr. Howell taught me (and what almost all financial advisors will tell you to do), if you have the cash to pay off your mortgage, you should.

If you carry a $250,000 mortgage – which even in retirement isn’t a lot in today’s world – even at 4%, you pay about $10,000 in interest in the first year.

And if you’ve done it right and limited how much of your Social Security is taxed, you’re in a lower tax bracket…10%, 15% or 25%.

Twenty-five percent is not cheap, but it’s better than 39.6%.

This means, even with the tax break in the 25% bracket, you still lose $7,500 in interest. That’s a lot of money to give away.

And the higher your rate, the higher your costs. Not everyone qualifies for 4% mortgages. At 5% and 6%, the numbers get heavy.

In the past, the rationale for holding a mortgage in retirement was to invest the money you would have used to pay off the mortgage. You could then use the income you generated to make your monthly payment. In other words, you would get to keep your money and pay the mortgage.

And that had been sound reasoning. It still is for some.

But now, the 20-year annualized return for the average investor is a measly 2.11%. Clearly, that’s not enough to offset the interest you lose on your mortgage.

And the older I get, the less debt I want on my back for two reasons…

First, the closer I get to retirement, the bigger the “what ifs” get.

What if rates drop and I can’t earn the full nut?

What if I lose some or all of what I have set aside?

And the “ifs” get bigger every year.

Second, even if I can generate enough via investing to pay the monthly nut, a large chunk of what I earn is still being handed over in interest.

That just doesn’t feel right anymore. It did once, but something feels amiss about giving away that much money.

In the 10% and 15% brackets, a mortgage deduction is so small it makes no sense.

And this one is still up in the air, but if Trump makes good on his tax reform, some could see even lower tax rates.

So thank you, Mr. Howell, for sharing your experience with a dumb kid, but it looks like time changes everything.

Good investing,