The Cash Flow Clock: For Retirees - Book - Page 54
The Cash Flow Clock
Leverage
One of the biggest concerns for households is managing their debt. Clearly,
consumer debt, with interest rates often exceeding 20%, has an extremely
destructive effect on our finances and should be avoided as much as
possible. Mortgage loans, however, offer home ownership opportunities that
otherwise wouldn’t exist for most families. Understanding how to leverage
our assets and liabilities is a critical aspect of financial planning.
Many financial gurus encourage everyone to get out of debt, especially
before they retire. That seems like a good idea. No one likes to owe money
or pay interest. But sometimes being in debt is better than the alternative.
There is never a good reason to pay 20% interest on consumer items that
have no chance of appreciating over time. But there are many good reasons
to take on a low interest mortgage to purchase real estate that not only
provides a home for our family but also an asset that can and should
significantly increase in value.
Many feel compelled to pay off their mortgage before they retire. If they
have $150,000 in a checking account earning zero interest and a mortgage of
$100,000 at 7%, then paying the mortgage off is probably a good idea.
If they have $30,000 in the bank and $500,000 in a traditional IRA with a
$300,000 mortgage at 2.5%, then it is probably not worth paying high taxes
just to save a little bit of interest, especially if we can get higher rates of
return on our assets and if we have enough income to cover the payments.
In some cases, our mortgage is already paid off but our income is not
sufficient to cover our expenses. A reverse mortgage is generally not a good
idea. But it is also not a good idea for older retirees (typically widows) to
deprive themselves just so that they can leave a paid off house to their
beneficiaries. As with any financial decision, leveraging the equity in your
home should be carefully considered while taking into account all of the
pros and cons. It is not an ideal option but it may be better than the
alternative.
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