Real Estate Matters

Whether to Pay in Full for New House Depends on Your Cash Flow Needs

By Ilyce R. Glink with Samuel J. Tamkin
Saturday, October 3, 2009

Q: We live in the Washington area and will be retiring in the next two years. We will be selling our home and moving to an area where the home prices are lower. Do you think we should pay cash for our new home, or should we pay half in cash and take a mortgage for the remainder?

My husband has retired from the Air Force, and we both work, so our retirement income will be good. We have discussed this at length but are not sure what to do. I would rather not have a house payment.

A: This is a great question. I think that the answer depends on a few issues: what your cash flow will be in retirement, whether you will need extra cash on hand for other things (such as a new car, travel or emergency fund), and whether you want to have a house payment.

The benefit of paying for the house in cash is clear: no monthly payment, which can dramatically increase your monthly cash flow. However, there is also a benefit to having a bunch of cash in a bank account, because it allows you to withdraw from various retirement accounts in the most tax-advantageous way possible.

If you don't know which way to go, the half-and-half solution is a good one. However, you'll pay most -- if not all -- of the fees of the larger mortgage and you'll have to pay the bill monthly. You will, however, have a small mortgage that you can pay off once you are a few years into retirement and realize that you don't need the excess cash in your bank account.

Interest rates are extremely low at the moment, and it's possible that once rates rise, you'll earn more with your cash than you are paying with the mortgage -- and that's a great scenario as well. Or, if you find that having even a small payment is annoying, you can use your free cash to pay off your mortgage.

One additional item to consider is whether you'll get any tax deductions from your mortgage payments if you take out the smaller loan.

While real estate taxes and mortgage interest payments are deductible on your federal tax return, if you take out the smaller mortgage your payments may or may not be more than the standard deduction. To get any benefit from the federal income tax deductions, your interest payments on your mortgage along with your real estate tax payments must exceed your standard deduction. For 2008, the maximum standard deduction for most taxpayers was $10,900.

If your interest and real estate tax payments are more than that, you should get some tax benefit from the deduction. If your payments are less than that, you will get no additional benefit on your federal income taxes.

Q: My husband and I are at different ends of the spectrum about refinancing our first mortgage and home-equity loan. The first loan has a $98,000 balance at 5.12 percent and has 9.2 years left. The second loan is a 15-year balloon at 6.3 percent. We're paying $200 per month extra in order to get it all paid off in 15 years, and we have about 11.2 years left on the loan. With our low interest rates, I do not want refinance, but my husband does. What do you think we should do?

A: You don't mention in your letter what your financial goals are if you were to refinance.

If you're looking to refinance both loans and take more money out of your equity, that's one reason to refinance. Another valid reason might be to refinance both loans and get a lower interest rate by consolidating both loans into a new first mortgage.

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