Thanks to historically low interest rates, refinancing a mortgage in recent years has been a no-brainer for many homeowners.
But when retirement is looming on the horizon, the decision to refinance can be more complicated—especially with interest rates now on the rise.
For some near-retirees, trading in a high-interest mortgage for one with a lower rate can result in substantial monthly savings, which can then be plowed into retirement accounts. But for many in their fifties and early sixties, it may be smarter to avoid refinancing before entering their golden years.
If homeowners are leaning toward refinancing, the time to act is probably now. As the housing market has stabilized, interest rates have crept up, “which makes refinancing less advantageous for everyone,” says David Blaylock, a Certified Financial Planner™ with LearnVest Planning Services.
The average rate for a 30-year fixed rate mortgage in January 2013 was 3.6%—by December, it was 4.5%. And the average 15-year fixed rate mortgage jumped from 2.9% to 3.6% over the same period, according to HSH.com, which publishes mortgage information.
The forecast for 2014? According to Keith Gumbinger, vice president of HSH.com, rates are expected to continue rising, although the increase is likely to be gradual.
“The incoming Federal Reserve chair, Janet Yellen, is likely to continue the low interest rates and supportive policies of the Federal Reserve for the foreseeable future,” Gumbinger adds. “My crystal ball is no better than anyone else’s, but I expect any changes to start very gradually and arguably later in the year—and then only if the economy is showing that it is strong enough to stand on its own two feet.”
Before deciding to refinance, says Blaylock, the first thing to take into account is what your income stream will be like in retirement. If all of your retirement income is dependent on market returns, such as from a 401(k), making fixed payments for many years might be a challenge. “If you’ve got pension income coming in or you have a nice social security benefit, “ he says, “it may not be as risky to hold a mortgage through retirement.”
So how can near-retirees make an informed decision about whether refinancing makes sense for them? To help guide your decision, we asked our experts to break down some of the pros and cons.
The Pros of Refinancing Prior to Retirement
1. It can give you extra cash flow. Refinancing to a lower interest rate can reduce monthly payments and may free up significant amounts of cash, which can be used to help you better prepare for retirement.
Having that extra cash on hand can be critical in the run-up to retiring, says Gumbinger. “You can bank that hard into your 401(k). You can maximize your cash savings. You can dump it into the market. Freeing up those extra funds can be very beneficial in order to solidify your position.”
"Near-retirees need to weigh their potential monthly savings against the fees they’ll be charged to refinance."
2. You could save money if you plan to move. If you know that you're likely to relocate in the next five to ten years, whether to a smaller house, a place closer to family, or even an assisted-living facility, refinancing may make sense.
With an adjustable rate mortgage, you can get a much lower rate for just the time period that you’ll be in the house, thereby freeing up cash, and then pay off the remainder of the mortgage once you sell. But you have to be fairly certain of your plans or you might get stuck with sharply higher monthly payments at the end of your refinance rate period.
Additionally, if you have at least 10 to 15 years left until retirement, you can also consider refinancing from a 30-year mortgage to a 15-year mortgage to save interest, lock in an even lower rate and pay off your mortgage by retirement—or at least close to it.
3. It may allow you to pay off other high-interest debts. People generally want to enter retirement with as little credit card debt or other high-interest debt as possible, says Blaylock, adding that some near-retirees who want to eliminate remaining debts elsewhere might “refinance some of the equity out of their home” to help pay off those debts.
The Cons of Refinancing Prior to Retirement
4. The costs might cancel out the savings. Refinancing isn’t free. Near-retirees need to weigh their potential monthly savings against the fees they’ll be charged to refinance in order to see whether those figures cancel each other out, especially if they plan to stay in the home for only the next few years.
5. There could be tax complications. Being responsible for a mortgage payment in retirement can create tax issues. You may be more likely to pull more money from retirement accounts in order to cover your mortgage payments, and that can mean triggering increased income taxes.
6. It could burden your heirs. Refinancing just before retirement may mean that you never get an opportunity to own your house free-and-clear before you die. “If you are 60 and refinancing with a new 30-year term, you can’t necessarily expect to pay off your house and leave it to your kids,” says Gumbinger. “There will probably still be a mortgage on it by the time the next generation gets it.”
7. You may retire with debt. Refinancing may lower your monthly payments, but it often means extending the length of your loan. Making mortgage payments well into old age is likely to be a burden on your finances—at a time when you are trying to live on less. Plus, it could cost you quite a bit more in interest over the life of the loan to refinance, especially if you're more than five to seven years into your current loan.
So if you have the option to rid yourself of your housing payment before retiring, you’ll likely have greater peace of mind. Added bonus: You can use the money for travel or other living expenses in your golden years.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. Unless specifically identified as such, the people interviewed in this piece are neither clients, employees nor affiliates of LearnVest Planning Services. LearnVest Planning Services and any third parties listed in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.