Don’t take a Mortgage into Retirement — Unless it’s a Reverse Mortgage

The first part of the above title is the clear consensus of personal finance experts, while the second part represents my own two cents. Allow me to explain.

As a result of both the credit and economic crises, the financial situations for many retirees has become increasingly precarious. The stock market is recovering, but still remains well below its peak in 2008. Meanwhile, the worsening employment picture, combined with stagnating wages, have forced those nearing retirement to dip into their savings accounts. Even worse, many of these borrowers have been unable or unwilling to pay down their mortgages, carrying a significant debt burden well into retirement.

The statistics speak for themselves: “In 1992, 18% of Americans age 65 to 74 had housing debt, according to government data compiled by the Employee Benefit Research Institute. By 2004, that percentage had risen to 32%. And in 2007 — the most recent year available — 43% of 65- to 74-year-olds had a mortgage. The levels of debt have also risen. In 1992, the median amount of housing debt carried by those age 65 to 74 was $24,609; 15 years later, the median amount owed was $69,000.”

The results of this trend, unfortunately, also speak for themselves. “Americans 55 and older have been the largest age group to file for bankruptcy recently, accounting for 23  percent of the more than 1 million filings in 2007, according to AARP. Older seniors are even more vulnerable, with bankruptcy more than quadrupling for those from 75 to 84.” It’s not difficult to connect the dots. Making mortgage payments without a steady source of income is a recipe for disaster. This is especially true in the current lending environment, where banks are increasingly hesitant to facilitate refinancing because falling home values are eroding borrowers’ equity positions.

There is also a common-sense argument for paying down your mortgage early rather than investing it via a retirement account: “In the current environment, your mortgage provides a better return on your money than other risk-free assets. ‘It is unlikely that many retired households will be able to earn a return on risk-free investments, such as bank certificates of deposit, Treasury bills and Treasury bonds, that will exceed the cost of their mortgage.’

For homeowners that qualify, there is an alternative: a reverse mortgage. Reverse mortgages have gotten a bad rap recently, from no less than the comptroller of the currency, who compared them to subprime mortgages. While certainly subject to abuse and scams, reverse mortgages can nonetheless provide a valuable benefit if utilized properly, by enabling borrowers to “extract cash from their home and still live in it.” I’ve explained how reverse mortgages work in previous posts, so suffice it to say that this product will only become more popular as desperate retirees run out of other options.