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When Home, Small Home May Be Sweet

With the first wave of baby boomers reaching the big five-oh, paying off mortgages ought to be taking center stage. Your retirement security may depend on whether you can knock off this debt before your current income drops.

The fifties is life's trickiest decade. With luck, you'll work all the way to 60 and beyond, earning more money and pension credits. But there's a good chance that your earning power will be cut, by disability, downsizing or a forced early retirement. Your next job, if there is one, probably will be at lower pay.

Homeowners in their fifties generally have been repaying a mortgage for 10 or 20 years. By the time they reached 60, the older generation had their homes pretty much paid for.

But that was before home equity loans. Many boomers have borrowed and reborrowed against their homes, for college expenses, a car, home improvements, even for vacations. Boomers also may have refinanced in the past couple of years, starting off with a new 15-year or 30-year loan.

What happens to people who have mortgages but no jobs? "They generally have to sell their homes," said John Reed, editor of the Real Estate Investor's Monthly in Danville, Calif. "That's a lot of homes on the market and a lot of people looking for cheap housing."

There are two sides to this story, one personal and one for investors.

If you're a real estate investor, the prospect of baby boomer sales suggests that the prices of larger homes won't rise very much and could very well fall. That might be especially true in the North, where forced sales will combine with the voluntary sales of older people moving south.

Demand will be focused on one- and two-bedroom homes in lower-cost areas, both for purchase and for rent. Those are the properties that rental home investors ought to look at, Reed says.

There also should be a boom in mobile homes, recreational vehicles for use as homes and condominiums. Condos generally aren't good investments, Reed says, because builders can create a huge new supply whenever demand heats up. But they clearly make sense for retired people of reduced means and health.

On the personal side, consider these four strategies for handling your housing problem in retirement:

While you're still working, quit borrowing from your home equity line of credit and start repaying it. Make monthly prepayments on your basic mortgage, too. The faster you repay, the less debt you'll have to deal with if you leave your job. Prepayments also are the ticket to owning your home free and clear, if you can keep your job until the normal retirement age.

You may be investing in stocks rather than prepaying your mortgage. That's fine, if you're putting the money into a tax-deferred retirement plan.

But non-plan investments are another matter. Here you have a choice: Put the money into your mortgage or put it into the stock market.

If you buy stocks and the market continues to rise rapidly, you could sell at retirement and use the proceeds to wipe out your mortgage loan.

But what if stocks plunge around the time you retire or become disabled? You'd have insufficient funds to wipe out your mortgage loan and insufficient time to wait for the stock market to recover.

Gamblers with large pools of savings might be willing to take that chance. Conservative investors will secure their homes first. When you prepay a mortgage, your return on investment equals your mortgage interest rate. On an 8 percent mortgage, for example, every principal repayment yields an 8 percent return, risk free.

If you lose your job and don't immediately find a new one, move rapidly to sell your house and find something cheaper. "Don't eat up your retirement savings while you churn out resumes and consult," Reed said.

To buy even a smaller house, you'll have to pay cash or have enough income from investments, spouse's earnings and pension to qualify for a modest new mortgage. Otherwise, you may have to rent for a while.

Consider selling early to avoid the rush. If you can telecommute or operate a small business from wherever you want, start looking for lower-cost places to live -- a smaller home, with a shorter-term mortgage, in a town where living costs are low. Reduced housing costs help you pay off debt faster and build a larger retirement nest egg than you otherwise would have had.