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Financial Planning > Tax Planning

Advisors Differ On How Much Boomers Should Leverage Debt

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If the use of mortgage leverage was a beautiful apple on the end of a branch, how far on that limb would financial advisors recommend that boomer clients stretch?

Financial planners contacted by National Underwriter warn against reaching too far. However, they add that it also depends on factors such as the boomer’s financial position and disposition for risk and whether the property is a client’s home or investment property.

Most people want to live in a debt-free residence at some point in their lives, according to D. Scott Neal, a certified financial planner who is president of D. Scott Neal Inc., Lexington, Ky.

How much debt is right for a client is a personal, qualitative decision rather than a quantitative decision based on whether the after-tax return on investments is greater than the after-tax cost of funds obtained using leverage, he continues.

The decision also depends on whether the boomer’s property is a residence or an investment property, Neal adds.

“Prudent” leverage, according to Neal, is generally no more than 20% of income which is allocated to debt service. “Once you get much above that, clients feel that they are being pinched by debt service.”

Neal says that age does not necessarily have to be a factor since “we are living longer and working longer.”

But, it does depend on how sure a client is of continued cash flow, he adds. If you have a job that could be at risk or if your income is variable, then a client needs to be more conservative, he says.

But, for conservative clients, even lucrative, secure financial positions might not sway their decision to limit leverage.

Neal recounts a couple in the medical profession who insisted on removing $200,000 from their investment portfolio to pay off their mortgage even though they were foregoing a 3% spread on their investments by doing so.

Dave Moran, a certified financial planner and senior vice president with Evensky & Katz, Coral Gables, Fla., says that the question is coming up more often. However, he explains, there is a difference between older boomers who he says are “hard wired” to avoid too much debt and younger boomers who are more willing to take it on. Older boomers are more likely to believe that “if you can’t pay cash then you probably shouldn’t buy it,” Moran says. “They (older boomers) will look at it but probably not act. Younger boomers will look at it and act quickly.”

But, he says that with interest rates so low, he is even fielding inquiries from older clients who are asking “Why not use other people’s money?” For instance, he says that one 73-year-old client is inquiring about an interest-only loan that he is considering for a third home. The client is a well-off risk taker who is receiving regular income distributions, he adds.

Moran says he and his client discussed the fact that interest rates are going up and his life expectancy is going down. “If the two meet at the wrong point, it could be devastating to his financial plan,” Moran says he explained to the man.

Moran says he believes that “there comes a time in life where borrowing to get what you wants has little advantage–especially the older one gets.” And, it depends on whether there is active or passive income, he continues. If a client’s income is passive, then he recommends that debt not exceed 30%.

J. Patrick Collins Jr., a certified financial planner and president of J.P. Collins & Associates, Towson, Md., says the question of mortgage leverage comes up quite a bit with his boomer client base which has an average age of 48.

There are two considerations, he cites: first, the “extremely important” peace of mind and second, the financial consideration, or what after-tax rate of return clients would need to average on their funds to outweigh the advantages of paying down their mortgage.

Collins says that 75% of his clients come down on the side of peace of mind. And boomers who are nearing retirement have to consider how much their regular retirement income will be impacted, he continues. So, for example, if a boomer owes $100,000 in debt at 6%, the cash outflow would start out at $6,000 annually. Approximately $150,000 in assets would be needed to generate that cash flow, he adds.

For those clients within 5 years of retirement, Collins says he would not exceed a 20% debt/assets ratio or a 15% debt/income ratio.

Collins says that if the interest payments reduce a boomer’s tax obligation, that has to be factored into the mortgage leveraging discussion and may make the returns achieved by leverage more appealing when being considered against the return on an investment.

Elaine Scoggins, a certified financial planner with Scoggins Financial, L.L.C., Tampa, Fla., says that for younger boomers, leverage makes home ownership possible.

But, she continues, when used to arbitrage an investment return against the mortgage rate, the few cases she has seen have not had happy endings.

“Pretty much to make this work, you’ve got to go out on the risk curve and invest in equities. I saw quite a few wealthy individuals try this in the late 90s because stocks were so appealing they just couldn’t bear to pay off the mortgage and not have this money ‘in the game.’ They were pretty sick about this decision by 2001.”

Scoggins says she tells clients to “sit down at the kitchen table and do your own projections of what you can afford. The bank can’t possibly know what you’re planning to do with your life after you close the loan and walk out the door. Ask yourself questions like: How many children do we plan to have? What lifestyle path am I going to choose–will it be the luxury living path, the middle of the road path, or a path with saving as the main priority that leads to early financial freedom? Factor all these things into what you can afford in the way of a mortgage payment.”

In general, George Middleton, a certified financial analyst with Limoges Investment Management, Vancouver, Wa., says he is “totally against leverage for someone at the baby boomer stage” because of the risk involved. If a client can’t meet the mortgage, “the range of answers is mostly unpleasant,” he adds.

Two exceptions, he notes, include a guaranteed income in retirement that will cover the debt or debt that will be paid off by retirement. “If you don’t have a choice (i.e., it’s a mortgage or no house at all), maybe renting would be better.”

The vast majority of boomer homeowners should be reducing their mortgage debt on their personal residence, according to William Howell, a certified financial planner with Howell Financial Advisers Inc., Noblesville, Ind. No mortgage debt is a realistic goal that will ease cash flow needs in retirement and will make more equity available in their home if they need it in retirement, he adds.

But leverage on an investment property can be “very lucrative,” Howell adds. The reason, he explains, is that it magnifies investment return.

For example, he says, “if a single family home investor has a 50% loan on a property and the home increases by 5% a year, his return on investment is 10% (5% increase in value divided by his 50% equity in the property). Likewise, leverage can also intensify the loss on an investment. In the above example, a 5% decrease in the value of the property results in a 10% loss on the individual’s investment.”


How much debt or mortgage leverage boomers should take on depends on factors such as their financial position and disposition for risk and whether the property is their residence or an investment property.


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