Q: We live in the Washington, DC area and will be retiring in the next two years. We will be selling our home and moving to an area where the home prices are lower. Do you think we should pay cash for our new home, or should we pay half in cash and take a mortgage for the remainder?
My husband has retired from the Air Force and we both now work, so our retirement income will be good.
We have discussed this at length but are not sure what to do. I would rather not have a house payment.
A: This is a great question. I think that the answer to whether you should have lower house payments or buy a house with no mortgage depends on a couple of issues: what your cash flow will be in retirement, whether you will need extra cash on hand for other things (like a new car, trip, emergency fund, etc.), and, whether you want to have a monthly house mortgage payment or not.
The benefit to paying for the house in cash is clear: No mortgage payments, monthly or otherwise, which can dramatically increase your monthly cash flow. However, there is also a benefit to having a bunch of cash in a bank account and having a smaller mortgage with lower monthly mortgage payments and an overall lower house payment, because it allows you to withdraw from various retirement accounts in as tax-advantageous way as possible.
If you don’t know which way to go, the half-and-half solution is a good one. However, you’ll pay most, if not all, of the fees of the larger mortgage on the purchase of your home and you’ll have to pay that mortgage bill monthly and deal with the mortgage lender from time to time. You will, however, have a small mortgage (a lower house payment) that you can pay off once you are a few years into retirement and realize that you don’t need the excess cash in your bank account.
Interest rates are extremely low at the moment, and it’s possible that once interest rates rise, you’ll earn more with your cash than you are paying with the mortgage – and that’s a great scenario as well. Or, if you find that having even a small payment is annoying, you can use your free cash to pay off your mortgage.
One additional item to consider is whether you’ll get any tax deductions from your mortgage loan payments if you take out the smaller loan.
While real estate taxes and mortgage interest payments are deductible on your federal tax return, if you take out the smaller mortgage (and benefit from lower house payments and lower monthly mortgage bills) your payments may or may not be more than the standard deduction. To get any benefit from the federal income tax deductions, your interest payments on your mortgage along with your real estate tax payments must exceed your standard deduction. For 2008 the maximum standard deduction for most taxpayers was $10,900.
If your interest and real estate tax payments are more than that, you should get some tax benefit from the deduction. If your payments are less than that, you will get no additional benefit on your federal income taxes.
I hope this helps you figure out your options.