For many boomers, refinancing a mortgage to take advantage of low mortgage rates could pose problems. As they approach retirement, boomers face the prospect of having to live on a reduced income. So, should they refinance, when doing so would extend the time it takes them to pay off the loan?
Financial advisors can help boomers think through their financial objectives when considering refinancing their home, to make sure they do not undermine any of their retirement or other financial objectives.
As a rule of thumb, the boomer client should be advised not to take on too much debt, says Mark Davis, part owner and vice president of Haas Financial Services Inc., Southfield, Mich.
“One of the factors we look at for pre-retirees or retirees is that if total debt service of both principal and interest is 15% or less of gross income, they wont have trouble handling it,” says Davis.
The maximum burden he would recommend such a client take on for mortgage debt would be equal to 25% of gross income for both principal and interest.
Davis also recommends looking at the clients total investment portfolio, minus any retirement income, to evaluate how much equity is in the home. Too much home equity actually can be a bad thing, he cautions.
“We want to make sure no more than 20% to 25% of the persons nonretirement portfolio is in the home,” he says. “You want to have an adequate amount tied up in a home as a hedge against inflation. But if you have too much equity in the home, you may have trouble generating the retirement income you need. They must have adequate amounts of productive assets in their portfolio, and a home is not productive.”
Davis believes it doesnt matter whether a client has a 15- or 30-year mortgage, as long as the mortgage payments fit well within the big investment picture.
“If you need a smaller mortgage payment, 30-year is OK,” he says. “If the spread is wide enough between 30 or 15, then you should try to be in a 15, but its not a disaster to be in a 30-year if you dont have the cash flow to handle a 15.”
Even variable rate mortgages can make sense, despite their notoriety for fast-rising interest rates, he says. The key is to recognize them as a short-term financing tool to fit certain limited cash-flow problems.
“Sometimes its OK to have a variable rate mortgage even if youre retired,” he says. “If your situation is changing and your cash flow needs it, get a variable rate. But that should be only for a short period, 4 or 5 years at most.”
Davis cites the example of his own recent divorce. Because of high legal fees and a big payoff for his ex-wife, and because he had an abundance of equity in his home, he used a variable rate mortgage to tide him over until the payoff is completed in 3 years or so.
“My debt is higher than it has ever been in my home and my cash flow is a little worse, but I have a low interest rate,” he says. “The interest rate will sky eventually, but after I pay off the spousal support, my cash flow will go up, so Ill be able to afford it. Even if rates go to 8% or 9%, Im better off going to a variable rate now.”
Whether refinancing makes sense for a boomer depends on the individuals needs, agrees David Peskin, chief executive of Vertical Lend Inc., Melville, N.Y., a company that helps advisors arrange mortgages for clients.
“If you are looking to make home improvements and can handle the payments, if you are consolidating debt or if you want to buy a 2nd home, refinancing can make sense,” Peskin says.
Often, clients run into cash-flow problems, and thats another instance when refinancing can pay off, even if they factor in closing costs, he notes.
“Lets say you have a $100,000 balance and the terms of the mortgage are 15 years. If I can refinance, Ill have maybe a $105,000 balance [factoring in closing costs], but Ill then have lower monthly payments. It can provide a big advantage,” he says.
Refinancing demands a close look at the benefits to the client, he says, and can be particularly beneficial if a client wants to make home improvements, for instance.
“It absolutely makes sense, because the house increases in value also,” he says.
“The main question is, does the client have an overall plan to get the income he needs?” asks Evan Levine, a financial planner at MML Investors Services Inc., New York, a unit of Massachusetts Mutual Life Insurance Company. “If its a matter of taking out equity to pay off debt at a lower rate, that would make sense. But I would not recommend it as a way to invest. I prefer no debt for investing.”
Reproduced from National Underwriter Edition, October 21, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.