Beware the Descent

Two thirds of the people who die on Mt. Everest die coming down the mountain. For climbers, most of the energy, training, and focus is spent working to reach the top of the mountain, but it’s actually twice as dangerous to climb down. Safely descending Mt. Everest requires a very different mindset and skillset to execute properly.

This mountain climbing analogy is often used in financial planning circles to highlight the extreme differences in money practices before and after retirement. In his book Re-Wirement, Jamie Hopkins states that earning years are about saving, but retirement is about managing cashflow. He warns that successful behaviors in one phase of life do not necessarily translate to other phases of life.

This is particularly true when considering the differences between wealth accumulation (working years) and wealth dissemination (retirement years). One widely accepted component of wealth accumulation is buying a home and paying it off, but your relationship to housing wealth (and your willingness to make a monthly mortgage payment) should change dramatically in retirement.

Cashflow or Liquidity?

With an evolving financial mindset in retirement, an important question needs to be answered: is it better to pay your house off completely and eliminate the mortgage payment, or carry a mortgage but keep some cash in your pocket? In other words, is cashflow or liquidity more important in retirement? The answer is "it depends," but thankfully, there is a mortgage product which allows for the best of both worlds.

A Home Equity Conversion Mortgage (HECM) allows homeowners or homebuyers over the age of 62 to access cash in their home without incurring a required principal and interest payment. This optimizes cashflow AND liquidity while transferring risk to the Federal Housing Administration (FHA) in the form of insurance. There are three clear reasons why seniors should not have a mortgage payment* in retirement, regardless of their liquidity preference.

Mortgages in Retirement Can Be...

Dangerous

A mortgage payment in retirement is dangerous, like coming down Mt. Everest with an extra 30 pounds in your backpack. Dr. Wade Pfau, one of the leading retirement experts in the US, says "Carrying high fixed costs into retirement [like a 30-yr fixed mortgage payment] exposes you to sequence of returns risk by forcing large withdrawals out of a retirement portfolio during down markets." I would add to his quote, “...and possible foreclosure for the surviving spouse, most commonly the widow." It is a tragic yet common occurrence for a husband to get sick, be in and out of the hospital, and burn through cash reserves before eventually passing away. Once that happens, the grieving widow is left with a severely depleted nest egg, a large drop in income, and an unmanageable mortgage payment. Many women who experience this are forced to go back to work, remarry, or sell their house and move in with their kids.

None of those options are inherently bad, but if financial stress is the primary motivating factor, that is bad. In this scenario, having a HECM in place early in retirement could help significantly by preserving the investment accounts, providing access to cash reserves in the house, and preventing the burden of a mortgage payment, all while maintaining ownership of the home.

Inefficient

Next, a mortgage payment is inefficient. Most mortgages today are 30-year terms because they have low payments. The problem with a 30-year fixed mortgage (or a HELOC) is the amortization schedule – the process by which the loan is paid back. If the mortgage is scheduled to be paid back over 360 payments, the breakdown of each payment for the first 10 years is overwhelmingly interest with very little principal reduction.

Regardless of the note rate, it is important to realize that you do not make money in real estate by making a mortgage payment, you make money in real estate through home appreciation. Mortgage payments on an amortization schedule are a double loss because most of the payment goes to the bank in the form of interest, along with the opportunity cost of those funds not being invested (or being withdrawn out of investments prematurely).

A HECM protects you from that opportunity cost because the monthly principal and interest payment is not required,* so you are free to divert those funds to a more advantageous account. While your mortgage balance will grow over time, your home value will likely grow more, and the interest accrued is largely accumulated on the back end, not heavily paid up front. Additionally, if you are using a 30-year fixed mortgage for a low payment, the required principal and interest payment for a HECM is zero – so by that metric, the choice is obvious.

Unnecessary

Finally, a mortgage payment is unnecessary. Why make a mortgage payment if you don’t have to? More importantly, why sign up for a loan program which would REQUIRE a monthly mortgage payment on a fixed schedule when there is another product which allows optional payments on a flexible schedule?

It’s always better to have more flexibility in a monthly budget so you can adjust as needed. Many academic studies have shown the HECM consistently helps retirees achieve a better result than not using one because people with more options generally outperform people with less.

HECM: A Superior Retirement Option

In summary, a Home Equity Conversion Mortgage is a far superior product for retirees compared to a standard 30-yr loan or a HELOC because it allows seniors to optimize liquidity and cashflow simultaneously. I believe it is also better than owning your house free and clear because the line of credit can be accessed in an emergency but only the funds drawn will accrue interest.

You don’t make money in real estate with a mortgage payment, you make money in real estate through appreciation. Making a mortgage payment in retirement is dangerous, inefficient, and unnecessary, but a HECM helps you mitigate all three of those risks. Climbing Mt. Everest and owning a home are both huge achievements – just make sure you have the right equipment for getting back down the other side.