If you are age 60 or above, and have decided that it’s time to buy a home—whether to downsize, retire, or for some other purpose—you’ll have to think carefully about the best way to finance it. By now, you may have more savings than your average homebuyer—but should you tap them?
A mortgage is inherently neither right nor wrong; but it amplifies your risk (for better or worse). You’ll be controlling a large asset with the help of other people’s money, which is great if the asset appreciates, but can be disastrous if the opposite happens. Even someone with a high net worth can lose big by borrowing too much—or in financial terms, being too highly leveraged.
For simplicity, let’s say you have a net worth of $100,000 and you invest it all in the down payment on a $500,000 house. If the home’s value drops 20% the next day, you suddenly have a zero net worth and your life’s savings is gone (at least on paper, and maybe for real if you end up having to sell soon).
On the other hand, if the home appreciates 20%, you’ll have doubled your net worth in one day—a 100% return overnight. (Of course, an all-cash buyer’s net worth would’ve simply moved up or down 20% because of zero leverage.)
Such is the nature of leverage.
The ultimate question is “How certain do I want to be to achieve a particular financial outcome?” The more certainty you require, the less leverage you’ll want to use. If you’re like most people, you’ll want to use less leverage (debt) as you age, because your appetite for uncertainty and extreme outcomes diminishes with time. This isn’t exactly the point in your life when you want to find a new job in another city and start over.
However, some people are comfortable with a large mortgage, even in retirement. It allows them to invest more outside the walls of their home. And it’s a strategy that works—until it doesn’t.
At any age, high mortgage debt is a bit like skydiving without a reserve parachute: you might be fine, but what if there’s a problem? If you run into financial difficulties (job loss, illness, or divorce, for example) you could quickly find yourself underwater in a home you can no longer afford. In such a case, the highly leveraged strategy quickly breaks down.
Of course, many people think, “I’m safe because I could always pay off my mortgage with other investments at any time,” and they’re often right. But add one catastrophic lawsuit or health problem to the mix and suddenly that approach could make you wish moving back in with mom and dad was still an option.
Financial advisers like to think of being mortgage-free as essentially a financial reserve parachute: a good idea, just in case—particularly as you approach retirement. At a time in life when income is harder to come by, and your ability to tolerate financial shocks is diminished, trying to service mortgage debt if something goes wrong could represent an unrecoverable threat.
The best way to address important risks as you age is to remove as much downside risk as possible from the things you absolutely cannot afford to lose, while taking calculated risks where you’re reasonably compensated by the potential upside. This ordinarily entails being mortgage-free by age 65. This way, no matter what happens, you’ll always have a soft place to land.