Basic financial planning taught investors not to be “house poor,” warning not to overextend your budget for your house to the detriment of your other financial obligations. Somehow, many investors overlooked the next lesson, “Don’t be House Rich, Cash Poor.”
“House rich, cash poor” happens when a significant portion of your wealth is tied up in an illiquid asset. This scenario happens when investors only skimmed the chapter on “Pay off Debt before Retirement.” That lesson referenced an earlier lesson on “Good Debt vs. Bad Debt.” At this point, you’re probably not surprised to learn the overall theme of financial planning is, “it’s all related.”
Here is what happens: Investors who are 10 years or less from retirement start planning for their liquidity once they stop working. They pay down credit cards, car payments, and other loans. Unfortunately, they often take it too far and decide they want to pay down or pay off their home.
For many, it is a dream to enter retirement with a home that is fully paid for. However, what many don’t realize is that your home is more secure from you defaulting on your mortgage in retirement than it is during your working years. During your working years, you likely have an emergency fund that covers six to 12 months’ worth of expenses should something prevent you from working. The rest of your lifestyle is dependent on your ability to earn. You carefully budget the cost of your home, your car, and your extracurricular activities to work within your monthly cash flow. However, consider what could happen if you lost your job and were forced into a lower-paying job for a few years. How would that affect your housing budget?
In retirement, if you’re following the Henssler Ten Year Rule, you have 10 years of liquid assets to pay for your living expenses—including your mortgage—mostly protected from any economic change that may or may not happen. Your remaining assets are invested in growth investments that should increase within that 10-year window. In years when your investments are up, you sell equities and move the money into a fixed-income investment to provide another year of liquidity.
This security of having 10 years of expenses in the bank allows investors the ability to carry a mortgage into retirement. Now, let’s refer to the lesson of “Control Your Expenses.” This can be done by controlling the cost of the funds you borrow. Traditional 30-year mortgages are around 3.25% as of August 2020. That is insanely low for 30-year money. Even if your current mortgage is around 4%, refinancing could trim $200–$300 off your monthly mortgage payment, therefore, increasing your monthly cash flow.
Yes, you are extending the length of your mortgage another 30 years, and you may end up paying more in interest over the life of the loan, but at 3% your mortgage is considered good debt as you likely have equity in the home and your asset is also generally appreciating. Additionally, saving an extra $2,400 a year before you retire could provide an additional source of after-tax funds for your retirement spending. Having a source of after-tax funds ideally results in withdrawing less from your tax-deferred retirement accounts, which means your retirement assets can continue to grow longer before you need to spend them and you’re paying less in taxes.
We warned you, it’s all related. Financial planning doesn’t just affect one area of your life. If you have questions regarding refinancing your mortgage to increase your cash flow before retirement, the experts at Henssler Financial will be glad to help: