Should Seniors Pay Off Their Mortgages?

Posted on October 27, 2016 by David Reiss

TheStreet.com quoted me in Should Seniors Pay Off Their Mortgages? It opens,

Increasingly, seniors are going against the conventional retirement wisdom about mortgages which, always before, preached that a cornerstone of a good retirement was to enter it debt free. That meant without a mortgage.

And yet about one-third of homeowners 65 and older have a mortgage now. That’s up from 22% in 2001. Among seniors 75 and older, the rate jumped from 8.4% to 21.2%.

The appeal, of course, is that home mortgages are cheap; 30-year fixed-rate loans are going out under 3.7%, and 15-year fixed rates can be had for 3.1%.

That puts the question in sharp focus: is this good financial planning or is it reckless?

Understand: age discrimination is flatly illegal in home loans. But law does not dictate financial prudence and the question is: is it wiser to pay off a home mortgage if at all possible – which used to be the prevailing wisdom? That still brings a sense of relief, too. Tim Shanahan of Compass Securities Corporation in Braintree, Mass. said: “It’s a great feeling to have no debt and a significant accomplishment to be able to tear up the mortgage.”

True.

But is this still the smartest planning? As more seniors take on home mortgages, experts are re-opening the analysis.

“The short answer to the question is it depends,” said certified financial planner Kevin O’Brien of Peak Financial Services in Northborough, Mass. O’Brien is not being cute. So much of this is individual-centric. O’Brien continued: “It depends on how strong the person’s cash flow is or not. It depends on how much liquid savings and investments they have after they might pay it off. It also depends on the balance they need to pay off in relation to their sources of cash flow, and liquid assets.”

Keep in mind, too: today’s retirement is not yesteryear’s. About one senior in four has told researchers he plans to work past 70 years of age. That means they have income. Also, at age 70, a person has every reason to claim Social Security – there are no benefits in delaying – so that means many 70+ year-olds now have two checks coming in, plus what retirement savings and pensions they have accrued.

That complexity is why Pedro Silva of Provo Financial Services in Shrewsbury, Mass offered nuanced advice: “We like to see clients go into retirement without mortgage debt. This monthly payment can be troublesome in retirement if people are using pre-tax money, such as IRAs, to pay monthly mortgage. That means that they pay tax on every dollar coming from these accounts and use the net amount to pay the mortgage.”

“If clients will carry a mortgage, then the low rates are a great opportunity to lock in a low payment,” Silva continued. “We encourage those folks who don’t foresee paying off their home in retirement, to stretch the payments as long as possible for as low a rate as possible.”

David Reiss, a professor at Brooklyn Law and a housing expert, offered what may be the key question: “I think the right question is – what would you do with your money if you did not pay off the mortgage? Would it sit in a savings account earning 0.01% interest — and taxable interest, at that? Paying off your mortgage could give you a guaranteed rate that is equal to your mortgage’s interest rate. So if you are paying 4.5% on your mortgage and you take money from your savings account that is not spoken for — like your emergency fund — you would do way better than the 0.01% you are getting in that savings account, even after taxes are taken into account.”

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Homes v. Bonds

Posted on October 20, 2016 by David Reiss

U.S. News & World Report quoted me in Your Home Is a Better Investment Than Bonds. It opens,

With bonds paying next to nothing, where can you turn for a respectable yield, guaranteed?

Well, how about your home?

Many homeowners look upon the homestead as a valuable asset they can tap for retirement through downsizing or a loan. They typically count on building equity the old-fashioned way, by gradually paying off the debt and enjoying some price appreciation.

There’s another option: making extra principal payments on the mortgage to reduce the debt faster. Every dollar used to pay down the loan earns a “yield” equal to the loan rate, since it saves you from having to pay that amount of interest. If your loan charges 4 percent, prepayments earn 4 percent, a lot more than you’d get in bank savings or a 10-year Treasury note, now yielding a paltry 1.8 percent.

“The advantage to paying off a mortgage over buying bonds depends on the cash flow created,” says Wyatt A. Moerdyk of Evidence Advisors in Boerne, Texas. “If the cash flow created by paying off a mortgage is greater than the yield of a bond investment, paying off the mortgage may be a wise move.”

“A very conservative investor who is averse to debt may find paying off his or her mortgage is the right choice,” says Eric Meermann, a planner with Palisades Hudson Financial Group in Scarsdale, New York. “If the alternative is sticking your money in a money market or savings account, you’re better off paying (the mortgage off) early.”

He adds, though, that prepaying a mortgage is not a good alternative to investments such as stocks that could be more profitable in the long run.

Mortgage payments involve various charges, often including sums for property taxes and homeowner’s insurance, but the key parts are the interest charge on the remaining debt and the principal payment that gradually reduces the debt over the years.

You have a right to pay extra principal, every month or in lump sums, and the payment slip you send with your check probably has a space for recording the amount.

Paying down a mortgage has a snowballing effect, since it reduces interest charges going forward. On a fixed-rate loan, that allows more of each month’s payment to go to principal rather than interest, and the loan is paid off early. With an adjustable-rate mortgage, extra payments reduce the required payment after the next annual reset, which applies the new interest rate to the remaining debt. After that, you can either pay less or pay what you have been, with more going to principal.

Prepayments can substantially reduce your interest charges over time, since less interest is required each month as the debt gets smaller. They also allow you to build equity faster.

A homeowner with a $300,000 mortgage for 30 years at 4 percent would pay $1,432 a month in principal and interest. By adding about $150 a month in prepayments, the loan could be paid off five years early, reducing total interest charges by about $40,500. Without the prepayments, the homeowner would still owe nearly $78,000 after 25 years.

“Many people like to have paid off their mortgage before they retire, and making extra payments on your mortgage can be part of that strategy,” says David Reiss, who teaches about residential real estate at Brooklyn Law School in New York City.

But although today’s low bond yields make mortgage prepayments appealing, stocks returns could beat prepayment yields substantially. Index funds tracking the Standard & Poor’s 500 index are up nearly 8 percent this year, and averaged 6.7 percent a year over the past decade. That’s a lot better than you’re likely to do with a mortgage prepayment, though the prepayment yield is guaranteed while a fund’s return is not.

Kroll on Mortgage Performance

Posted on January 22, 2015 by David Reiss

The Kroll Bond Rating Agency has issued an update of its residential mortgage-backed securities model methodology, Residential Mortgage Default and Loss Model. Before the financial crisis, ratings models seemed to be very reliable, data-driven models of probity and caution. We have since learned that different mortgage vintages (the year of origination) can behave very differently and ratings models could be based on simplistic assumptions. Hopefully, the updated Kroll model does not suffer from those flaws, although their key takeaways seem pretty basic to me:

Underwriting standards are the fundamental determinant of mortgage quality.
Negative home equity creates a major incentive for borrower default, resulting in substantial credit loss.
Credit scores continue to have value as a relative indicator of risk.
Inflation of real home prices above the long-term mean is unsustainable and represents increased credit risk. (4-5)

Kroll’s update does include some interesting revisions, including,

Reduced default expectations for purchase loans. It has long been observed that purchase loans generally have lower default risk than refinancings, all else being equal. This is attributed to the fact that a purchase represents an actual arms-length transaction which yields a more accurate view of a home’s value than an equivalent refinancing transaction. However the pre-crisis mortgage vintages showed high levels of default associated with purchase mortgages. This was largely due to the practice of extending credit to first time homebuyers, often on very favorable terms despite these borrowers having little credit history or poor credit history. This poor performance by purchase loans was reflected in the historical data regression analysis used to develop the RMBS model.

Based on analysis focused on both jumbo and conforming prime mortgages, KBRA has found that, for these loans, the traditional benefits of purchase loans remain well established, and we have adjusted the model ‘s treatment of purchase loans to reflect lower default expectations relative to equivalent refinancing mortgages. This revision is effective with the publication of this report.

* * *

Penalty for high debt-to-income (DTI) loans. While the KBRA RMBS model does not contain a specific risk parameter based on DTI, it is our opinion that very high DTI loans can bear significant incremental risk. When we began to encounter newly originated loans with back-end DTIs in excess of 45%, we assigned an additional default penalty to such loans. This has been documented in presale reports for those rated RMBS backed by loans with high DTIs. (3)

Time will tell if Kroll got it right . . ..

Reiss on Prepaying Your Mortgage

Posted on May 29, 2014 by David Reiss

Newsday quoted me in Prepaying Your Mortgage. It reads,

You’ve heard that it’s good to be early — whether for work, a job interview, or going to bed. But what about prepaying your mortgage? When does it make sense?

THE PROS

Fewer payments and a faster payoff are appealing. “For many people it’s a no-brainer to prepay . . . Essentially you’re getting a guaranteed return in the form of the interest you aren’t paying,” says David Reiss, who teaches residential real estate finance at Brooklyn Law School. “It’s hard to find an investment in today’s market that gives you an equivalent risk-adjusted return.”

Money you no longer put toward the mortgage can go elsewhere. Being mortgage-free in retirement helps cash flow on a fixed income, points out Leslie Tayne, a Melville attorney specializing in financial issues.

Take your monthly payment, divide it in half and make that payment every two weeks. On a typical mortgage, this could shave off almost four years, says Jason Auerbach of First Choice Lending Services in Manhattan.

THE CONS

Paying extra on your loan “means you can’t use that money for other more important things such as contributing to a retirement account,” Tayne says. If your assets are earning a higher rate of return than the interest rate on your mortgage, it doesn’t make sense to pay early. Run the numbers.

Also, once the loan is paid, will you miss the tax deduction? Does your loan carry a prepayment penalty? Can you really afford to pay extra? Better know the answers to such questions, advises Jeff Tanenbaum, a broker with Halstead Property in Manhattan.

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