One rule of thumb that’s commonly incorporated into financial plans assumes clients will have paid off their mortgage before entering retirement. Not only does it ease cash-flow concerns for initial retirement years, but it can also create a sense of calm as clients become debt free.

But this strategy is not always true to real life, a recent study by the Center of Retirement Research at Boston College concludes. In 2015, Americans over age 60, regardless of income, were 24% more likely to hold mortgage debt than the same age group in 1980. In looking at common causes, only 9% of this increase was due to an increase in home ownership. Wealth, education, race and location of the mortgage holders were also not significant factors.

One major factor, though, that did explain some of this increase were the prevalence of lower income households and those without pension income having larger mortgages for a longer period of time. However, despite that factor, the rate of defaults and financial hardships did not significantly increase.

What else has caused the increase in mortgage debt among boomers?

Bloomberg News

A 30-year fixed-rate mortgage in 1980 peaked at 16.32%, while in 2015, it peaked at 4.05%. Mortgage rates have steadily declined over the 35-year period allowing for people to purchase newer, larger houses for the same payment or refinance their current mortgage debt and take advantage of a lower monthly payment.

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If we looked at just the S&P 500 returns from 1980 to 2015, we can see that 29 years posted positive returns, while only six years posted a negative return. The overall U.S economy, barring the dot-com bust and the recession in 2008 and 2009, has been growing and posting positive returns, increasing the overall wealth of many Americans. In seeing investment accounts grow and mortgage rates decline, it has made little sense to pay off a mortgage early.

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Using this strategy, home owners can delay Social Security and start collecting full benefits at age 70.

So instead of sticking to rules of thumb, what if advisors embraced the trend that many boomers are holding onto their mortgages for a longer period of time, instead of paying them off. How could we be changing recommendations and portfolio designs to accommodate this contrarian viewpoint?

Home equity can pay for initial years of retirement: Depending on mortgage rates and current equity in a client’s home, they can refinance their current mortgage to fund the initial years of retirement. This will allow their portfolio to grow without having the drain of initial income withdrawals, and leave a bigger portfolio balance to draw from later.

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Instead of sticking to rules of thumb, what if advisors embraced the fact that more boomers are holding onto their mortgages. How would this change recommendations and portfolio designs?

For example, Jane is 66, has $200,000 equity in her home that’s available to withdraw and she can refinance at a 4.5% interest rate. Her portfolio is valued at $1 million, generates 7% in annualized returns and she’ll be needing income of $40,000 per year. If she takes the $200,000 in equity, she’ll be adding $12,000 in additional mortgage payments to her fixed annual costs. She’ll now need $52,000 per year to cover her lifestyle.

However, in having this $200,000 in cash at her disposal, she can use this to live on for the next four years. In that time, her portfolio — assuming the 7% annualized rate continues — is worth just under $1,350,000. If we go by the 4% rule, her portfolio should still be able to support her increased cash needs. She has also been able to delay withdrawing Social Security and will now receive a higher amount, allowing her to rely less on her portfolio for her living expenses.

This strategy can also change planning strategies for high-net-worth clients.

Doug and Susan have three houses worth $3 million in total, with mortgages of $750,000. They have a portfolio of $5.7 million invested in a 60/40 portfolio generating annualized returns of 8%. They need $185,000 to maintain their lifestyle, including servicing their mortgages. Doug and Susan are both executives, will both be retiring this year at age 65 and expect to live into their 90s.

Some planning approaches might suggest these clients should take a portfolio withdrawal, pay off the mortgages, reduce retirement cash flow needs and live a debt-free lifestyle. But if they take a contrarian approach, they can take out mortgages up to $2,400,000 on the properties, providing them with $1,650,000 in cash. They can then buy a joint 10-year period certain single premium immediate annuity which would provide them with approximately $185,000 per year. The mortgage debt of approximately $145,000 would be serviced by the portfolio. After a period of 10 years, the portfolio — even with these withdrawals — would have grown to approximately $10 million.

During this period, they have delayed Social Security and both are collecting full benefits at age 70, providing $85,000 to their household income. They are now 75. Their portfolio withdrawals to service the mortgages and their lifestyle are $245,000 ($300,000 - $85,000 in Social Security payments). With this easily being supported by a portfolio two-thirds its current size, they now partition off part of the portfolio to invest aggressively to provide funds for their grandchildren and various charities.

It’s clear in these scenarios that the portfolios of the clients may have been able to sustain their lifestyle without the use of cash-out refinancing. But clients sometimes need more certainty in their situation than what the past has offered, and they need some protection against future events. Introducing these scenarios may provide some piece of mind. Additionally, I have seen many clients stick to the rules of thumb and strive to pay off their mortgage by retirement. There is not just one correct solution to this issue. All that matters are that clients are comfortable with their financial plan and aware of any potential consequences that may arise.

Dave Grant

Dave Grant

Dave Grant, a Financial Planning columnist, is founder of Retirement Matters, a planning firm, in Cary, Illinois. He is also the founder of NAPFA Genesis, a networking group for young fee-only planners.