Mortgages should be treated as part of your investment portfolio and retirement strategy, and learning to manage your mortgage along with the rest of your finances is just a part of life. Younger borrowers and older borrowers have different goals and challenges when refinancing their mortgages. It's important to learn why and how your mortgage financing strategy should change as you get older.
Mortgage Planning at 25: Not Your Grandfather's Refi
Younger homeowners differ from older ones in significant ways, and these difference should be accounted for when selecting a mortgage product or strategy. When you're just starting out, you're likely to have fewer assets, less home equity, and a shorter credit history. What you have more of is time.
Younger homebuyers tend to sell and move fairly frequently. Life-altering events -- finishing college, getting married, starting a family, moving to take a better job -- often involve an address change. Keeping that in mind, the automatic preference an older homeowner has for the fixed-rate mortgage may not necessarily be appropriate for you. First-time homebuyers generally keep their houses an average of three to five years. So why take on a 30-year fixed-rate home loan when you can get a 5/1 hybrid adjustable rate mortgage (ARM) and save a full percentage point on the interest rate? The 5/1 hybrid ARM supplies a fixed interest rate for the first five years, then the loan's interest rate adjust each year after that. But the odds are you'll be long gone by the time that happens. How much can you save? On a $300,000 mortgage, getting a 5/1 at 4% instead of a fixed mortgage at 5% saves you $177 a month. Over five years, the money you save from having a lower monthly payments could be used to supplement your expenses -- from a nice used car to partially offsetting the rise in monthly payment caused by a higher loan reset rate.
Early Retirement Is Not for You or Your Mortgage
Mortgage experts love to extol the virtues of paying off a mortgage early. Yes, you save thousands in interest charges, yes, you have the security of fully owning your home and having no mortgage payment, but this strategy isn't appropriate while you still carry high-interest debt, leave retirement accounts underfunded, or have insufficient cash set aside for emergencies. In addition, younger investors' portfolios are generally geared to take on higher risk in pursuit of higher returns, so money paid to reduce the principal on your mortgage is money unavailable for higher-yielding investments. Interest-only loans can be, on occasion, appropriate for people in this age group. If you are certain of substantial increases in income, a loan that allows you to pay less when you earn less and then pay more when you earn more is sensible. It can help you skip the starter home and avoid the expense of selling, moving, and buying again as you become more affluent.
Mortgage Planning at 45: Avoiding a Midlife Money Crisis
By age 45 you have probably hit your financial stride and have a home worth keeping for some time. You've established credit, have probably accumulated some assets, and are in your peak earning years. At the same time, you should be seriously planning your retirement, and with any luck your kids will be out of college and/or out of your house soon.
Refi, But Don't Get Silly
That being said, this is probably not the time to refinance your home so you can buy a boat with the proceeds. It is a good time, however, to think about freeing yourself of your mortgage before you retire. If you want the lowest mortgage rates, refinancing to a 15-year mortgage typically gets you an interest rate about a half percent less than the 30-year mortgage, and can shave thousands off your total repayment. This is only a good strategy if you can continue to fully fund your retirement accounts while making the higher payment of a 15-year mortgage. If you are concerned about losing your job or another financial emergency, you can still prepay a 30-year mortgage by sending in extra money each month, opt for bi-weekly mortgage payments, or writing checks for principal reduction whenever you have extra cash. Choosing one of those options means you aren't obligated to make a 15-year payment if money gets tight. The problem with paying extra is that few homeowners are disciplined enough to make the financial commitment over the period needed to make a sizable dent in their loan balance. According to the FDIC, despite their good intentions, 97.3% of homeowners do not consistently pay extra on their mortgage loans.
Mortgage Planning at 65: Enjoying the Sunset
Financial planners tend to be of two minds about mortgages for retirees. On one hand, many people aren't comfortable with the idea of a mortgage obligation after retirement. On the other hand, it's not a great idea to have all of your investment dollars in real estate -- or in any single investment vehicle, for that matter. So it could make sense to trade some home equity for cash and diversify your holdings. This strategy seems more and more common. In 1992, only 18% of homeowners aged 64 to 74 had mortgage debt. In 2007, that figure rose to 43%. Refinancing and home equity borrowering have created or extended payments where none existed before. If the recession depleted some of your retirement savings, you may want to refinance to recast your loan so you can put some funds back into your investments in order to rebuild them.
Retirees also face challenges when refinancing because mortgage lenders want to see income before they grant home loans, and as a retiree, your income may be diminished somewhat. Other retirees run into unexpected problems if they take part-time jobs or go from employee to consultant. You need a two-year history of this kind of income before a mortgage lender can count it for loan approval purposes. If you plan on retiring soon or changing the way you earn money, consider refinancing first, while your work history is solid and your income is sufficient.
Finally, if you have substantial equity but would like to improve your cash flow, look into reverse mortgage products. They aren't for everyone, but they can help you cover expensive emergencies or improve your quality of life. They can even be used to downsize and purchase a new home.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.