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Should You Be a Lifetime Renter?

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In most of our parents’ books, buying a home was not only a stepping stone towards adulthood — it was the way to achieve long-term financial success. Not surprisingly, many 20-, 30- and even 40-somethings grew up with that message and, as a result, held the same belief. That is, until a few years ago, when the real estate bust changed everything.

Who would have thought there would ever be a time when it would actually be cheaper to rent rather than buy in many areas of the country?  Not to mention the scenario of being stuck in a home because of its decreasing value, or one where, years after retiring, you are still paying off a mortgage.

According to the U.S. Census Bureau’s 2009 American Housing Survey, approximately one million people over 65 still had mortgages for 65.9% or more of their home value, which means someone in this predicament with a $200,000 home still owed $130,000 or more to the bank. Worse yet, more than 300,000 seniors had so-called underwater mortgages: they owed more than their homes were worth.

All of which begs the question: How do you retire the way our parents and grandparents used to, without a mortgage?

One way to do it would require some long-term planning and might be too late to consider for homeowners in their 40s or 50s who have refinanced several times and may now owe more to the bank than the homes are worth.

Yet in hindsight, the solution is deceivingly simple: only purchase a home if your intent is to pay off your mortgage before you reach 65. That will require you to live by to several homeownership rules.

First, view home equity loans and lines of credit as borrowing against your retirement. What do financial planners say about taking a loan from your 401(k) or IRA? Avoid at all costs. Same applies to your home’s equity.

Second, if you refinance to get a lower interest rate, take a shorter-term loan: if you had a 30-year mortgage, for example, get a 15-year one if you can afford it.

Third, keep in mind how long you have until retirement before you sell or buy a new home. For instance, if you’re 30 now and sell your home in 10 years to buy a new one, you’ll want to pay off the mortgage on your new home in 25 years. To do this, you can choose a 15-year mortgage to be paid off by the time you turn 55. During the 10 years until you turn 65, you can then save what used to be the mortgage payments into a separate account to be used for property taxes and maintenance during retirement.

Alternatively, you can also take out a 30-year mortgage and make one extra mortgage payment each year to accomplish your mortgage-free retirement goal. (You would still need to set aside some cash for property tax and maintenance, though.)  

The Lifetime Renter’s Retirement Plan

Considering what happened in the past three years, many former homeowners have now become renters (voluntarily or not), and many renters are simply choosing to continue renting instead of buying.

If you choose to rent, possibly for your entire lifetime, you will need a rental nest egg saved up for housing expenses in retirement.

One way to prepare for renting in retirement is creating a so-called “rental mortgage.”

What is rental mortgage?

This is basically a fancy name for a savings or investment account that you create before you retire, meant to cover your rent in retirement.You set aside a certain amount of cash each month, as if you’re paying a mortgage on a home you own. So in essence, you are paying a mortgage to yourself — except it’s all principal, you earn the interest, and you’re not paying maintenance or property taxes.

Do not take out any money out until your 65. Once you turn 65, you can use those savings to pay your rent, or even buy a home all-cash.

Calculate your rental mortgage payment

Use an online mortgage calculator such as this one on Bankrate.com to calculate what your mortgage payment would be based on home prices in the area you live (or the one where you’d like to retire).

In the “mortgage term” field, enter the number of years you have until retirement (or until you turn 65). For instance, if you’re 30 years old now, put in 35 years.

When you calculate your mortgage payment, click on the “Show/ recalculate amortization table” button, which will show what you would pay in principal and interest each month. For instance, a $200,000 30-year mortgage with a 5% interest rate would have $240 going to principal the first month. Each month, the payment amount allocated towards principal gets larger, while interest paid to the bank gets smaller.

You can save the full mortgage payment, or just the principal. By depositing the principal amounts into a savings account for the next 35 years in our example, by the time you turn 65 you should have accumulated $200,000, plus interest.

Pick a safe investment vehicle

Treat money saved from your mock mortgage as if you were living in your retirement home now, and don’t risk it in the stock market. Chat with your financial advisor about your safest investment options, such as money market accounts or certificates of deposit (CDs).

What if you can’t afford it all?

There is one big catch with this plan: it assumes that you can afford to make two housing payments (your real-life rent and your imaginary mortgage) instead of just one. That’s not going to be a realistic scenario for everyone.

Obviously, if you have credit-card debt or other high-interest loans, paying them off should be a priority. What’s the point of retiring mortgage-free and with a hefty housing-expenses nest egg, but saddled with other high-interest debt?

Some people might only be able to afford saving the difference between their current rent and what their mortgage payment would be if they bought a home in the area where they want to retire. That’s fine: as long as you’ve got a plan for buying a home or continuing to rent after you retire that doesn’t affect what will likely be a lower, fixed income than you’re used to in your working years.

The trick to affordable housing in retirement isn’t buying a home, it’s making a retirement plan based on your individual situation. 

Reyna Gobel is a freelance journalist who specializes in financial fitness. She is also the author of Graduation Debt: How To Manage Student Loans and Live Your Life.