Yesterday I called my investment adviser to discuss the possibility of buying a smaller house in a nicer neighborhood. I was operating under the assumption that I would apply all the proceeds from my present paid-off home’s sale to the new house.
He, however, urged me to finance as much of the new purchase as possible—80 percent—and invest the remaining cash in the stock market. The 5 percent drawdown (projected “take” for retirement income) from the increased amount in savings would cover the cost of the mortgage and, when combined with Social Security, would give me enough to live on. And then some, in his opinion.
Leveraging debt, as we know, is something that goes against my bourgeois grain. However, since this is a very smart guy with an MBA, I reckoned I’d better listen up.
So today I ran a bunch of figures, in an attempt to see the practical outcome of borrowing against real estate instead of paying it off. The fly in the proverbial ointment is the $1,000/month payment I’m making toward the house my son and I are purchasing as an investment, which we would like to hold until after the housing market turns around. That could be anywhere from two to ten years.
I assumed my monthly costs of groceries, clothing, gasoline, and the like will not change significantly, since I do not eat out and don’t have to buy special clothing for the office. Gas probably will drop a little, but not much, since the Valley’s sprawl requires everyone to drive from pillar to post just to accomplish ordinary errands. Monthly routine nonnegotiable costs such as tax & insurance, utilities, and the like probably won’t change if I move to the cute little house in Willo, but will drop sharply if I move to Sun City.
So: would I be better off to mortgage my home and add the cash to savings? Here’s what my calculations show:
In the first scenario, my real estate agent gets the seller to come down off his price by $10,000 and I get my full asking price of $325,000, netting a grandiose $274,100 after the Renovation Loan and closing costs are paid.
That’s depressing. Even without the cost of the Investment House, I can’t afford to move to the cute little house in Willo. Moving on…let’s suppose the guy is right, that carrying a mortgage on my house would allow me to leverage debt in such a way that I would have more to live on in retirement. Maybe that strategy would make it possible for me to stay right where I’m living. Suppose I did that right away, while I have a job, since no lender is likely to fork over 240 grand to an old lady on Social Security.
Wow! I profit by a fantastic $1,076. What keeps me in the black is my salary. In theory the positive balance is a bit higher, because I get a small income tax advantage. That notwithstanding, this does not look like it’s worth the effort, or the psychological stress of diving into debt up to my eyeballs.
Once all I have to live on is Social Security plus retirement savings, this scenario puts me deep in the red. Clearly I can’t afford to stay in my house using this strategy after retirement.
So, what if I pay off the Renovation Loan, leaving my house free and clear, and try to stay here after I retire. Can I afford that?
What with the ever-increasing property taxes and skyrocketing utility bills, it doesn’t look good. The only way I can stay here is to sell the Investment House prematurely, taking a loss on that. This will cause my son also to take a financial hit, which I would prefer not to do.
Ohh-kayyyy…. This leaves moving to Sun City as the last option. Costs there are much lower, because taxes are controlled and home and car insurance is much lower. Videlicet:
This represents a significant savings on the cost of living in my present (much preferable) home. So, what happens if I finance a sorta comparable house, which out there will cost around $260,000?
Lovely. I’m still in the red. Either my son has to come up with an extra $542 a month, or we have to sell the Investment House. This is getting depressing: so far, no matter what I do, I can’t afford to retire. Period.
But I can afford to pay for a Sun City house in full. What happens then?
OK! I probably could survive if I move to Sun City, buy a place for much less than I get for my present home, and continue to live frugally. The amount of play in my present budget is $29 a month, and so in this scenario my lifestyle would not change much. Except, of course, I would be enjoying the silence of the mausoleum in a ghetto for old folks.
In any event, this comparison suggests that paying off your debt is better than leveraging debt, at least in terms of providing you with cash to cover your living costs. Math is not my strong point, and there very well may be something in the logic that I just don’t understand. But if these figures are right, paying off all debt—mortgage included—is the sanest way for a middle-class earner to go.