Tag Archives: tax deduction

Paying off Mortgages before Retirement

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By Erwin Bosman - Imported from 500px (archived version) by the Archive Team. (detail page), CC0, https://commons.wikimedia.org/w/index.php?curid=71327793

I was quoted in Should You Pay off Your Mortgage before Retirement? It opens,

Getting rid of what may be your largest monthly expense and unburdening yourself of debt are great benefits of becoming mortgage free at any age. But it may be particularly attractive as you approach retirement.

“Back in the 20th century, people used to burn their mortgage documents once they had paid the loan off,” said David Reiss, a law professor who specializes in real estate and consumer financial services at Brooklyn Law School in New York. “That practice reflected the freedom that many felt from no longer having to borrow to own their family home.”

Indeed, that emotional freedom helped make the idea of paying off your mortgage before retirement conventional wisdom for financial planning.

And there are still good reasons to consider it.

“It’s always helpful to pay attention to rules of thumb like, ‘You should pay off your mortgage before retirement,’” said Reiss. Those rules are often true under typical circumstances. But you want to understand the assumptions behind the rules and see how they compare with your situation.

Traditionally, the main reasons to pay off your mortgage before retirement are to get rid of the monthly payment (perhaps allowing for a better balance of income with expenses) and to gain the emotional benefit of having your home paid off, said Casey Fleming, a California-based mortgage advisor and the author of Buying and Financing Your New Home.

But there can be other considerations as well. These can include:

Each of these areas can provide good reasons to sunset a mortgage, but also good reasons not to. It all depends on personal circumstances, so it’s important to take a closer look.

Balancing income and expenses

For some people, retirement means shifting to a fixed income that may be lower than what they brought in during their working years. Eliminating a significant bill ahead of time — like a mortgage payment — may make living on a fixed income a little more affordable.

But that may not be the case for everyone.

“For instance, most people see a significant drop in income when they retire,” Reiss said. “If that is not the case for you — you have a great pension, your spouse is still working, etc. — then you have more flexibility when it comes to your mortgage.”

When matching income and expenses in retirement, it’s important also to take a long-term view. For example, if your spouse will retire a few years after you do, you may want to increase your mortgage payments to time their retirement with your loan payoff date.

Emotional benefits

When you carry a mortgage, someone else has a powerful legal hold on your home. Forget to pay your homeowner’s insurance bill? Your lender can buy coverage — very expensive coverage — on your behalf. Miss too many loan payments? Your lender can foreclose.

As noted earlier, taking back that power made paying off the mortgage a celebratory event. Not only did people burn mortgage documents, but some also hung eagles over their doorways, using the symbol of American freedom to herald their freedom from mortgage debt to visitors.

Yet you’re never truly free of foreclosure risk — you’ll still have to pay your property taxes even after you’ve extinguished your mortgage. And most people should still carry homeowner’s insurance, even when a lender doesn’t require it — which means you’ll have to answer to your insurance carrier. If they don’t like the wood-burning stove in your garage, you’ll have to take it out unless you can find another company that approves having it.

Still, many people feel differently about their homes once the mortgage is paid in full.

Liquidity

Paying off your mortgage before you retire — assuming that you’re not already on schedule to do so — means using assets you might otherwise allocate elsewhere.

Generally, if you have enough money in your retirement fund to handle your living expenses comfortably, plus a cushion for extraordinary expenses (like medical bills as you get older), then it’s safe to pay off your mortgage, Fleming said.

But it may be unwise to use liquid assets, such as stocks, bonds, and cash, to pay down your mortgage as you approach retirement because home equity is far less liquid. If, after you retire, you wish you had that money back, you may have to look at options for selling your home, refinancing it, or getting a reverse mortgage, all of which require time and fees.

Return on investment

Paying off any sort of debt gives you a guaranteed return on investment. If you’re carrying a mortgage at 7 percent, paying it off may be attractive because you typically would have difficulty earning a guaranteed 7 percent long term anywhere else.

Of course, with a lower mortgage rate or a higher risk tolerance, early mortgage repayment becomes less attractive from an ROI perspective. So, it becomes a personal choice about risk and lifestyle.

Taxes

Another argument in favor of paying off your mortgage before retirement is if you won’t lose a tax deduction by doing so.

“The standard deduction is pretty high now, and many seniors don’t benefit anymore from the mortgage interest tax deduction,” Fleming said.

If your standard deduction is greater than your itemized deductions — and for the vast majority of Americans, it is — you can’t reduce your tax obligations by deducting your mortgage interest.

However, the standard deduction in effect today could halve in 2026. The doubling of the standard deduction that became effective in 2018 is one of many tax code provisions that’s set to expire at the end of 2025.

And even if your mortgage interest by itself doesn’t get you over the standard deduction threshold — in 2023, that’s $13,850 for single taxpayers, $27,700 for married taxpayers who file jointly, and $20,800 for heads of household — when combined with other itemizable deductions such as charitable donations and state and local income taxes, paying off your mortgage early might increase your tax bill.

“If you pay off a mortgage early, you are saving on mortgage interest, but you may also be giving up the mortgage interest deduction,” Reiss said. “If you do not pay it off early, you can earn interest in a bank account, but you will be paying taxes on that interest. You want to think through the consequences of your choice to see which is the most financially attractive, including the tax consequences.”

Can Seniors Get Mortgages? Should They?

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photo by Bill Branson

TheStreet.com quoted me in Can Seniors Get Home Mortgages? Should They? It reads, in part,

Senior citizens can and are getting approved for mortgages, and we are not talking reverse mortgages or home equity lines of credit, but – in many cases – 30-year fixed loans. Even when the borrower might be 85 and the actuarial probability of making it to the end of the loan term is nil.

The federal government is blunt: age cannot be used to discriminate against applicants for home loans. Capacity to repay is a factor – for seniors and every other borrower – but a lender cannot turn down an applicant just because he is 65…or 75…or 85. And loans are getting made.

Which raises the other question: is it wise for the borrower? Bankers can take care of themselves, but seniors need to ask: should I be borrowing a lot of money on a house at my age?

In Vancouver, Wash., Dick Kuiper – who said he is “approaching 70,” as is his wife – “just purchased a new home last year and got a 30 year mortgage at just under 3%, and we both believe this was a brilliant move.”

“We first made sure we made a large enough down payment so we would always have positive equity in the home,” Kuiper elaborates. “With that calculated, we looked at the alternatives, either pay in cash – which would naturally come out of our savings – or take out a mortgage. We looked at what we could get by putting the same amount of money into a retirement annuity with a downside guarantee. That annuity pays a minimum of 5% for life and currently is paying in the 8% to 9% range. Do the math. We’d be crazy to pay cash for the house.”

Kuiper’s right. For his wife and him, it made no sense to pay cash for a house – not when mortgage rates are breathtakingly low.

Case closed? Not at all.

Ash Toumayants, founder of financial advisors Strong Tower Associates in State College, Pa., said that in his experience few seniors ever want another mortgage in retirement after they settled up on their first one. “Most are excited when they pay it off and don’t want another one,” Toumayants says.

Another fact: to get a mortgage, a senior has to demonstrate to a lender a capacity to repay. Age cannot be used against a senior, but lack of cashflow can. And many seniors just have sizable trouble qualifying for a mortgage. “The trick is whether they have enough income to qualify or not,” said Casey Fleming, a mortgage expert in Northern California who said that he right now is working on a loan for an 85-year-old client.

Brian Koss, executive vice president of Mortgage Network, an independent mortgage lender in the eastern U.S., elaborated: “For seniors thinking about getting a mortgage, it’s all about income flow. If you have a consistent source of income, and a mortgage payment that fits that income, it makes sense. Something else to consider: if you have income, you have taxes and a need for a tax deduction. With a mortgage, you can write off the interest.”

*     *     *

But then there is an ugly issue to confront. Is the senior arriving at this purchase decision on his own steam? Brooklyn Law professor David Reiss explained why that needs to be asked. “Seniors should discuss big financial moves with someone whose judgment they trust (and who does not stand to benefit from the decision). Elder financial abuse is rampant.”

Reiss added: “What has changed in their financial profile that is leading them to do this? Is someone – a relative, a new friend – egging them on or leading them through the process?” Reiss is right in the caution, and that’s a concern that has to be satisfied.

Foreclosure Body Count

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respres

Case Western’s Matt Rossman has posted Counting Casualties in Communities Hit Hardest by the Foreclosure Crisis (forthcoming in the Utah Law Review) to SSRN. The abstract reads,

Recent statistics suggest that the U.S. housing market has largely recovered from the Foreclosure Crisis. A closer look reveals that the country is composed not of one market, but of thousands of smaller, local housing markets that have experienced dramatically uneven levels of recovery. Repeated waves of home mortgage foreclosures inundated certain communities (the “Hardest Hit Communities”), causing their housing markets to break rather than bend and resulting in what amounts to a permanent transition to a lower value plateau. Homeowners in these predominantly low and middle income and/or minority communities who endured the Foreclosure Crisis lost significant equity in what is typically their principal asset. Public sector responses have largely ignored this collateral damage.

As the ten-year mark since the onset of the Foreclosure Crisis approaches, this Article argues that homeowners in the Hardest Hit Communities should be able to deduct the damage to their home values caused by the Crisis from their federal taxable income. This means overcoming the tax code’s usual normative assumption that a decline in a home’s value represents consumed wealth and, thus, is fully taxable. To do so, this Article likens the rapid, unusual and enduring plunge in home values experienced by homeowners in the Hardest Hit Communities to casualty losses – i.e. damages to personal property caused by a sudden force like a storm or a hurricane – which are deductible. The IRS and most courts have insisted this deduction is limited to physical damage. This Article carefully dissects the law and principles underlying the deduction to reveal that the physical damage requirement is overbroad and inequitable. When viewed in the larger context of other recent tax code interventions that allow those who have experienced personal financial harm due to a crisis to reduce their income tax base accordingly, home value damage in the Hardest Hit Communities actually fits comfortably within the concept of a casualty loss.

Notwithstanding its normative and equitable fit, the casualty loss deduction poses several administrative challenges in its application to the Foreclosure Crisis. This Article addresses each challenge in turn, explaining the extent to which the Treasury Department and the IRS, through administrative action and/or a careful application of case law precedent, can resolve it. The Article also identifies and grapples with the distributional reality that the casualty loss deduction, in its current form, provides a small or no return on lost home equity for a sizable number of low and middle income homeowners, which would make it a problematic method of recovery for homeowners in the Hardest Hit Communities. To make the deduction a better and more equitable fit under the circumstances, this Article identifies two, larger-scale modifications the federal government could adopt: (i) changing the method by which a casualty loss is valued for damage caused by the Foreclosure Crisis and/or (ii) lifting the floors and limits Congress has over time imposed on the deduction, as it has done for those taxpayers most heavily impacted by several recent hurricanes and droughts.

The article offers a creative response to ameliorate an aspect of the foreclosure crisis. Rossman concludes, “Once these homeowners are considered equally worthy of claiming a casualty loss, the question then shifts to how the IRS, the Treasury Department and/or Congress can best adapt and address the administrative and distributional challenges attendant to utilizing the casualty loss deduction in this context. These challenges are not insurmountable barriers, but rather issues to be carefully considered and strategically addressed.” (67)

I can certainly imagine some of those challenges, such as how to reliably identify a “permanent transition to a lower value plateau,” but articles of this type are just what we need as we try to figure out how to address housing crises of this magnitude.  While there was a big gap between the housing crises of the Great Depression and the Great Depression we can be sure that there will be another such event at some point in the 21st century.