Should You Retire Your Mortgage?

This week Clark Howard, consumer advocate and longtime host of The Clark Howard Show, sits down with Morningstar's The Long View podcast to discuss budgeting in the pandemic, mortgages, and if you should buy or lease a car.

Here are a few excerpts on homebuying and retirement from Howard's conversation with Morningstar's Christine Benz and Jeff Ptak:

Homeownership and Homebuying

Benz: You referenced homeownership as a goal, and we've had this frenzied homebuying market over the past year; seems like there's a shortage of inventory in a lot of markets. So how can homebuyers protect themselves in this sort of environment? Especially first-time homebuyers who aren't necessarily selling something that has appreciated a lot. How can they make sure that they're not buying at a high point? Howard: I went through this with my oldest child, who is 32, and she and her husband buying their first house in the teeth of a very rough time to be a first-time homebuyer. And my advice to them is the same I give to any first-time homebuyer right now. The core to how you deal with an inflated market, where you have really inflated prices on homes, but at the same time depressed rates on mortgages, even though mortgages have gone up recently, they're still by historical measures very low. It's your cycle of ownership that is core and key to dealing with an inflated housing market. And so, I encourage first-time homebuyers to buy a home that they feel, barring some unexpected life circumstance, that they can spend a decade or more in that property. Because the lower monthly payments, the lower interest rate, that gives you that lower payment, you help negate over time a lot of the inflated housing price that you're having to absorb as a first-time homebuyer.

Should You Rent or Buy?

Ptak: And what if you don't have that kind of time horizon, would you advise someone in that situation to rent? Howard: I know this is cruel and brutal, but I recommend that people rent. And a lot of, particularly younger married couples, really don't like when I say that, because there's something about the circle of life that you pair up, and maybe or maybe not you're going to have kids, but then you go and you buy a home, that's part of the process. But the reality is, that is a psychological thing, when your ownership cycle is going to be shorter in a time where prices have gone up so much in housing, that in most markets in the United States, renting in a shorter term is a smarter decision for your wallet than buying. Because we're outrunning people's affordability of homes and builders are doing a lot. If you read their financials, they're doing a lot to acquire land banks, as they refer to it, to continue to build; we've got a lot of multifamily being built. The imbalance with a shortage of homes that may be somewhere around 4 to 5 million housing units in the United States, that's going to solve over time. And so, the runup in prices we've had is not sustainable, adjusted for inflation over a long period of time, because you just can't support a housing market where you've outrun people's ability to afford. I used to say you needed to own a home seven years to make the math really work with the costs in buying and the cost out selling. But right now, I've added to that hitting the decade, the 10-year mark, because of all those factors I just named--that being a renter becomes a much smarter decision every year you intend to own less than 10 and particularly less than five years.

The Cost of Buying a Home

Benz: You referenced some of those transaction costs associated with buying and selling homes. Sometimes I think those really get lost in the shuffle or people underestimate that. Can you talk about that? Because it seems like that's another headwind. If you're someone who is planning to cycle through home purchases pretty quickly, that can really cut into any money that you might be able to earn from that experience. Howard: Sure. And one thing that can frustrate people in the financial industry with me is a lot of times I do back-of-the envelope numbers. So, know that the number I'm going to give you now is not precise. But it's to try to make a point to prospective homebuyer. I call it the 10-and-10 rule. The figure you're going to have roughly 10% of the cost of buying a home in and 10% out. There are so many expenses involved in establishing that house. All the expenses with getting that mortgage, closing on it, the money you have to spend on possessions and purchases for the house; things you might even not think about that you're going to have to buy: a lawn mower, washer and dryer. There's an endless list of things you have to buy going in. And, so, I just try to get people to think of whatever the purchase price is, and figure it's 10% of that for everything all in involved in you buying that home. And then obviously going out when you're selling. Most people are going to have a significant real estate commission, plus the repairs a buyer might have you make, and other expenses you have fixing up the property for sale. So that's why I just call it the 10-and-10.

Retiring Your Mortgage

Benz: How about older adults who are getting close to retirement, should they retire their mortgages prior to retirement or is it really individual dependent? Howard: There's a certain amount of individual nuance on it. But when I talk to somebody who's, let's say around 50, and they're moving to a new home, and they're asking me about the interest rates on 30-year mortgages, I pretty much am ready to have my blood pressure checked. Because that means if you at 50, are taking out a new mortgage, you still have it at age 80. And that's no way to live. When you cycle into a home in the core years of middle age, I want you to take out a 15-year loan, I want you to be mortgage-debt-free. So that you have wiggle room, you have freedom in retirement to be retired. Very few people--unless they're in a job where they make a great deal of money, and they've been just fantastic savers, or they're the tiny percent of people who get a wonderful employer-provided pension--very few people have as much cash flow in retirement as they had pre-retirement when they were still working full time at their chosen job or profession. I want people to be mortgage-debt-free in retirement, but I don't want you to do it at sacrifice of everything else. I will talk to people who are several years from retirement, and they've stopped saving any money for retirement. And everything they're doing is devoted to this single-minded goal of being mortgage-debt-free. But the issue with that is that you can't eat your house. So, if you have not generated money in savings that you can draw on in retirement, it's fantastic, you own your house free and clear. But you still have a significant cash flow problem. It is all based on where the person is financially at the point they're asking me the question. And the question you posed to me, I get most often from people about mid-50s or so--that's when they're asking me, "Well, what do I do? I got this mortgage, and I want to be able to retire at blah, blah, blah, age? Should I just do everything I can to pay off the mortgage?" And the answer is, it really depends on me, going through a series of questions with them about everything else they've done, and everything they've got that they've saved.

What’s Wrong With Reverse Mortgages?

Ptak: Maybe to stick with that topic, housing and that older demographic, I think you've been pretty critical of reverse mortgages. But it's also true that some older adults have more housing wealth than they have in liquid assets. So, who are reverse mortgages right for and, conversely, who should avoid them? Howard: I love that you asked me this question. Because reverse mortgages are for some people, the way I put it, is least-bad choice. Because there's a lot of expenses involved in establishing a reverse mortgage. So, you eat up some of that equity you've worked so hard to build. On the other hand, if somebody is extremely cash poor and their house, for many people, will be their best asset they can draw on. And if you don't have kids, you're worrying about inheriting, doing a reverse mortgage is great. I want you to go through with an accredited housing counselor to understand all the elements of doing that reverse mortgage and know that you're going to pay the fees up front. But the ability to get money every month, almost like using your house as your own personal pension fund is a viable alternative when someone is facing poverty, because they don't have, beyond Social Security, they don't have real resources other than the value of their home. What I do like is for a parent to say if they've got one, two, or more adult children, say, "We want you to know this is what we're thinking of doing--we're thinking of taking out this reverse mortgage. It means there'll be no house inheritance. Just want you to know about this." And that's the situation. The alternative, particularly if you have a child or two who's fairly affluent, they may do the equivalent of being the provider of the reverse mortgage for you, which would eliminate the costs that you would have with a reverse mortgage. They end up inheriting the property, and so they're the ones that float the value to you. That is an alternative where you have parents who are short of funds and adult children who are in a position to support their parents' lifestyle.

Should You Loan to Your Children?

Benz: A related question is the flip side of that, where the parents float the private loan to the kids who want to buy a house. And so, it's maybe a better yield to the parents and so forth. But can you walk through whether you think that's a good idea within families, for the parents to be making the loan to the kid? Howard: It's a great idea for the kids; it's not necessarily a great idea for the parents. Because as a parent, if your kid comes to you for a private mortgage, and let's say they've not been the most careful and responsible with their money. And the mortgage payments are late, or they don't show up. What are you going to do as a parent? You're going to foreclose on your own kid, or you're going to support your kids' lifestyle? And the problem of not being financially responsible, it is a very, very difficult thing. I get a lot of questions from people about co-signing for a car loan for their kids or lending their kids money. I'm such an optimistic person, but on this one issue, I'm gloom and doom with people. I really lay out, "Well what would you do if your kid did this? Or your kid didn't do that? Or your kid just walked away? Or they didn't make the payments on the car, are you going to make the payments?" And the funny thing I hear over and over again, from parents, girlfriend, boyfriend, siblings, when I ask the question about being a co-signer, for a vehicle loan, and I ask, "Are you in a position to take over the payments, if the person you want to co-sign for doesn't make the payments?" And I'll tell you, probably three quarters of the time, the answer is, "No, I can't afford those payments." And I'm like, "Then you can't co-sign, because it's your credit that gets trashed. And you also are in position of facing repo action where they come after you for deficiency of the loss from the repo of the vehicle and your credit's fouled up for seven years, and so on." So, I work really hard to be a complete nuisance to people, when they ask me a question about doing a private loan or being a co-signer. Because they need to know that there's more to it than just being a generous soul or feeling guilty.

This article was adapted from an interview that aired on Morningstar's The Long View podcast. Listen to the full episode.