Ed Zurndorfer discusses the reasons why refinancing for soon-to-be retirees may make sense at this time.
Edward A. Zurndorfer
Those federal employees who are within 5 to 10 years of retirement and who intend to remain living in their personal residences for at least five more years may want to consider refinancing their mortgage at this time before mortgage interest rates increase from current low rates. This column discusses the reasons why refinancing for soon-to-be retirees may make sense at this time.
Many financial advisors recommend that soon-to-be retirees pay off their mortgage before they retire, and their regular paychecks stop. But given the current housing environment in the U.S. – mortgage interest rates currently at historic lows and housing values throughout the U.S. generally high – many financial advisors are recommending the refinancing of a mortgage at this time rather than paying it off.
Refinancing today at current low mortgage rates coupled with high property values and “cashing out” (borrowing more than the balance left on the current mortgage) while refinancing can generate cash to among other things can be used to add to one’s investments, to pay off credit card debt, to pay off parents’ student loans, or to make capital improvements to one’s home.
Another reason to refinance before one retires is that qualifying for a conventional mortgage without a regular paycheck is much harder compared to when one is retired and receiving less monthly income in the form of retirement or pension income. This is because it is a potential borrower’s current income that matters most to mortgage lenders, and to a lower extent a borrower’s savings. A potential borrower’s monthly income consisting of salary income will usually be larger compared to retirement and investment monthly income.
What About a Reverse Mortgage as an Alternative to Refinancing?
Instead of refinancing one’s mortgage to a lower interest rate and possibly “cashing” out thus making cash available, there is also the option of a reverse mortgage for individuals aged 62 and older. It is interesting to compare the total costs associated with a refinancing an existing mortgage obtaining a reverse mortgage. Note reverse mortgages are available only to homeowners aged 62 and older.
Suppose a homeowner aged 62 were to refinance an existing mortgage, borrowing $125,000 for 30 years at an interest rate of 2.5 percent. Closing costs for refinancing typically average five percent for the amount borrowed. Five percent of $125,000 equals $6,250.
In contrast, according to the National Reverse Mortgage Lenders Association a reverse mortgage in the amount of $125,000 would cost a homeowner in upfront costs $18,000. Interest charges of $5,800 would accrue annually although the interest would not have to be repaid until the homeowner moves out of the home.
The following table summarizes the difference in this case of refinancing a 30-year mortgage of $125,000 at 2.5 percent versus a purchasing reverse mortgage.
|Expense||Refinancing||Purchase Reverse Mortgage|
|Average Annual Interest||$1,800*||$5,800**|
There are those employees close to retirement who may want to simply pay off a higher rate mortgage. In today’s mortgage interest rate environment, a higher rate mortgage is mostly likely a mortgage in which the interest rate exceeds 4 percent. Also, there is at least 10 years remaining on the mortgage and the homeowner does not seek a “cash out” refinancing. Given today’s reduced interest rates, refinancing to a lower rate could lower monthly payments by half or more. Lowering monthly housing payments during retirement can be extremely beneficial in retirement when there is less monthly income comparted to when one is working full-time.
But there are some pitfalls in refinancing a mortgage that individuals should be aware of. When homeowners refinance into new 30-year mortgages, even though their monthly mortgage payments may be lowered, they essentially reset the interest meter on their mortgage payments. Over time, they add years to the life of their mortgage loan and, as a result, end up paying tens of thousands of dollars of additional mortgage interest.
Also, the Tax Cuts and Jobs Act of 2017 (TCJA) changed the rules regarding the deductibility of mortgage interest on the “cash-out” portion of a refinancing. In particular, the mortgage interest paid on the “cash-out” portion of a mortgage refinancing can only be deducted on one’s income taxes when the excess cash proceeds are used to make capital improvements to the home. Capital improvements would include adding a room, redoing a kitchen or bathroom, landscaping, etc.
Some borrowers like the idea of paying off credit card debt r car loans with their “cash-out refinancing” proceeds. This is because mortgage interest rates are much lower than the typical credit card interest rate and in some cases car loan rates as well.
Those employees who are close to retirement and who doubt their ability to maintain monthly housing payments with a refinanced new mortgage are advised not to refinance their mortgages. The risks are severe in the event of not being able to make monthly mortgage payments resulting in possible mortgage loan default. In short, the consequences of losing one’s home in case of a mortgage default is much worse compared to missing out on a “bargain” refinanced mortgage.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those, Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.