As more Americans have bucked conventional wisdom in recent years and retired while still carrying a home mortgage, the market upheaval has created an opening to consider refinancing.
The average rate for 30-year fixed-rate loan dipped below 3.15% in early March—versus an average rate of 4.5% in 2018 and 3.9% in 2019—and recently hovered around 3.5%, raising the question of whether older owners should refinance their home loans even if it means adding years to their payoff date. For someone with a $300,000 loan, the difference between 4.5% and 3.5% is nearly $200 a month and $62,000 in total interest over 30 years.
“From a pure budgeting standpoint, lowering a payment by even a few hundred dollars can drastically impact your quality of life and the strain on your investments and accounts,” says Scott McCaskill, an advisor with McCaskill Financial in Frederick, Md.
For retirees, however, the decision to refinance a mortgage isn’t simply a matter of weighing upfront costs against monthly savings to calculate how long it takes to break even. Older homeowners need to have a clear understanding of what they hope to get out of a refi, and what it means for the big picture of their planning.
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If saving money over time is your primary objective, first do the math to see if that pans out. For one thing, there are upfront costs, which typically range from 2% to 5% of principal. Depending on how much time you have left to pay, that money might be better used prepaying your mortgage by putting additional funds toward principal each month, says Keith Gumbinger, vice president of HSH.com.
What many people also overlook is that refinancing restarts the clock on amortization. If you’re 20 years into a 30-year loan, refinancing can reduce your monthly payment, but you could pay more in total interest over the life of the loan. That is, unless you refinance to a lower rate but apply the savings to principal each month to prepay your mortgage. “In essence, nothing would change about your retirement, but now your mortgage would be paid off much sooner than expected,” says McCaskill.
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If saving money over time is your primary objective, first do the math to see if that pans out. For one thing, there are upfront costs, which typically range from 2% to 5% of principal. Depending on how much time you have left to pay, that money might be better used prepaying your mortgage by putting additional funds toward principal each month, says Keith Gumbinger, vice president of HSH.com.
What many people also overlook is that refinancing restarts the clock on amortization. If you’re 20 years into a 30-year loan, refinancing can reduce your monthly payment, but you could pay more in total interest over the life of the loan. That is, unless you refinance to a lower rate but apply the savings to principal each month to prepay your mortgage. “In essence, nothing would change about your retirement, but now your mortgage would be paid off much sooner than expected,” says McCaskill.
Even though financial advisors are no longer dogmatic about making sure retirees burn their mortgages before retirement, there is still tremendous value in doing so.
“When we map out cash flow needs for our retired clients, we look at income and expenses over a 10-year timeframe,” says Anne Marie Stonich, managing director of financial planning at Seattle-based Paracle Advisors. They make up the difference between expenses and guaranteed income with an allocation to cash, and short- and intermediate-term bonds. More expenses in retirement means pulling more money out of the core portfolio. “Having a mortgage makes sense when you’re younger and that money is likely to earn more in the market, but you lose much of that benefit when you’re retired,” she says.
David Reyes, founder of Reyes Financial Architecture in San Diego, agrees. “If you can pay off your mortgage before or soon after retirement, you should,” he says. Doing so eliminates a major fixed cost and effectively locks in a guaranteed rate of return—equal to mortgage interest—that is tough to beat even when rates are this low.
If you can, pay it off
For a growing number of retirees, however, this isn’t the reality. A 2018 survey by mortgage banker American Financing found that 44% of Americans aged 60 to 70 have a mortgage when they retire, and 17% don’t expect to ever pay it off.
If downsizing isn’t an immediate option and cash flow is a concern, paying off a mortgage might not be the first priority. “If you’re 60, have a mortgage, and are worried about cash flow, the focus should be on reducing the size of your payment,” says Reyes.
That might mean stretching out the life of a loan or even looking at an interest-only option. A creditworthy borrower could get a 3.5% 10-year interest-only loan that converts to a fixed-rate loan. For a $500,000 loan, that’s the difference between paying $2,387 a month for a 4% traditional loan versus $1,458 for an interest-only loan, he says.
He says he rarely recommends interest-only financing, “but at least it is an option for the right client.” He adds that most retirees have enough equity in their homes to provide a buffer against any decline in value.
Cash flow is key
In general, qualifying for a mortgage in retirement is no different than it is in the working years. Lenders want to see stable sources of income, such as pensions, annuities, and Social Security. They’ll also factor for retirement savings withdrawals, though they typically assume only 70% of an investment portfolio in their calculations, says Gumbinger.
Retirees thinking about a refi should not assume that rates are going to go lower. Among other factors, “there has been an absolute crush of refinancing business that is overwhelming the mortgage-lending system,” Gumbinger says, noting that applications for refinance mortgages shot up 79% in the week ended on March 6. “To try to temper incoming demand…some lenders stopped passing along new declines in rates and others began to price defensively so as to deter new business from coming in the door.”
While there are many uncertainties, including how the coronavirus outbreak will affect appraisal access and home values, refinancing may be more feasible once the wave of consumer interest subsides.
In the meantime, retirees should organize their documents and start talking to lenders. There’s no need to rush, says Gumbinger: “The low-rate climate is likely to be with us for a fair while.”
Other caveats
If saving money over time is your primary objective, first do the math to see if that pans out. For one thing, there are upfront costs, which typically range from 2% to 5% of principal. Depending on how much time you have left to pay, that money might be better used prepaying your mortgage by putting additional funds toward principal each month, says Keith Gumbinger, vice president of HSH.com.
What many people also overlook is that refinancing restarts the clock on amortization. If you’re 20 years into a 30-year loan, refinancing can reduce your monthly payment, but you could pay more in total interest over the life of the loan. That is, unless you refinance to a lower rate but apply the savings to principal each month to prepay your mortgage. “In essence, nothing would change about your retirement, but now your mortgage would be paid off much sooner than expected,” says McCaskill.