How to deal with this retirement budget-buster

What's the biggest spending item for retirees? You're likely to say that would be medical expenses. But the average retiree actually spends more on housing. And the largest housing expense is usually the monthly mortgage payment.

Prior generations of retirees celebrated making their last mortgage payment, with some going so far as to burn their mortgage paperwork. However, compared to earlier generations, today's retirees are more likely to still have mortgage debt. 

A recent report by the Consumer Financial Protection Bureau (CFPB) found that the percentage of homeowners age 65 and older with mortgage debt increased from 22 percent in 2001 to 30 percent in 2011. Likewise, among homeowners age 75 and older, the rate more than doubled, rising from 8.4 percent to 21.2 percent. Plus, seniors' median mortgage debt increased by 82 percent during the same period, from about $43,000 to $79,000.

Most likely, these trends are the result of boomers continually trading up their homes or refinancing them to fund major purchases, such as remodeling, college education for their children or expensive vacations.

Given these trends, it's not surprising that another recent report by the CFPB noted that mortgages were the leading source of complaints to the bureau from consumers 62 years old and up.

Should you pay off your mortgage when you retire? While many people say yes, you'll hear conflicting opinions from investment experts.

Some pros will point out that a mortgage represents a fixed living expense and by paying it off, you've significantly reduced your living expenses. This better enables you to ride out future stock market crashes or declines in real estate values, which are inevitable given the length of time people are living after they retire. 

The basic idea: You can sleep better at night if the mortgage is paid off.

However, other investment pros point out that mortgage interest rates are near all-time lows. For example, Bankrate.com reports an average rate of 4.07 percent for a 30-year fixed loan, and 3.33 percent for a 15-year fixed loan. These experts note that historical stock market returns have been much higher, averaging close to 10 percent over the long run. They might advocate a so-called arbitrage strategy that relies on your investments earning more than the interest rate on your borrowing.

Acting on the belief that your investments can earn more than current mortgage rates makes sense only if you invest all your retirement savings in the stock market. If you have any money in bonds, certificates of deposit or money market funds, chances are good those investments earn returns that are less than current mortgage rates.

For example, the current rate on 10-year Treasurys is barely above 2 percent, and high-quality corporate bonds are yielding around mid-3 percent. And of course, CDs and money market funds are bringing in close to zippo. In this case, an arbitrage strategy would instead support using your bond investments, CDs or money market funds to pay off your mortgage.

In addition, if you're significantly invested in stocks, you'll need to be able to withstand a significant equity market decline without panicking and selling at the market bottom. We've experienced four major stock market crashes in the past 30 years -- how many more are likely to happen during your retirement years? 

Having no fixed monthly mortgage payment can help you more comfortably -- and less anxiously -- ride out equity downdrafts.

To help you consider the issues concerning mortgages and housing costs, here are some smart tips for retirees and near-retirees:

  • Your 50s and 60s are a good time to reconsider your housing situation, particularly if your kids have moved out and you're no longer working at your career job. Many people use this opportunity to downsize, reduce mortgage obligations and other housing expenses, and find a home and community that better suits their needs. If you wait until your 70s or 80s, you may not have the energy or ability to make such a move.
  • If you decide to stay in your current house, resist the temptation to refinance with a 30-year mortgage, which could require payments into your 80s or 90s. Instead, investigate a 15-year fixed mortgage.
  • Take the time to analyze your retirement savings portfolio to compare your mortgage rate to the rates you're earning on both stocks and bonds. An arbitrage strategy that uses bonds to pay off mortgage debt might reduce your investment risk. Before you implement such a strategy, however, check with your accountant to understand the tax implications. 
  • Carefully consider any reverse mortgage and understand the fees you might be paying if you decide to pursue this option. Reverse mortgages can be used strategically to improve your financial security, but they aren't for everybody. Don't use them frivolously to fund vacations or large discretionary expenses.

If you need help deciding whether to maintain mortgage debt in your retirement years, find a financial pro who's qualified and not conflicted by how he or she is paid. For example, if your adviser earns a fee based on assets under management, that fee will go down if the recommendation is to pay off your mortgage with your savings. 

Similarly, don't take investment advice from a mortgage broker. Find somebody else to help you weigh the pros and cons of maintaining mortgage debt. After careful consideration, if you decide to refinance or use a reverse mortgage, then use the broker to help find the best deal.

Millions of boomers are approaching their retirement years with modest retirement savings. It only makes sense to be a savvy planner and consider all your assets and debts to help make ends meet in retirement.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.