Financial advisers are fielding calls from clients wondering what, if anything, they should be doing with their home loans now that 30-year fixed mortgages have pierced 6%.
Admittedly it’s not as big a deal as Roger Bannister cracking the 4-minute mile or Hank Aaron smashing Babe Ruth’s record of 714 career home runs. Nevertheless, it did set off some fireworks last week when the average rate on 30-year fixed-rate mortgages broke the 6% barrier, especially for those who are in or near retirement and wondering what to do about their mortgage debt.
For the record, at this time last year the standard 30-year fixed-rate mortgage stood at 2.86%, according to Freddie Mac. And with the Federal Reserve determined to get inflation below its 2% target — August CPI came in at an ugly, above-consensus 8.3% last week, in case you missed it — the chance is slim to none that borrowers will see a sub-3% rate again for a long, long time.
They will, however, likely see the values of their homes fall, as the last time the rate on a 30-year fixed mortgage rose this high was during the financial crisis nearly 14 years ago. That’s certainly not a period homeowners or investors remember fondly, which is why financial advisers are increasingly fielding calls from clients wondering what they should be doing, if anything, with their home loans.
PAY IT OFF
Mary Steele, managing partner at Freehold Wealth Management of Stifel Independent Advisors, encourages her clients, mostly young professionals, to pay down mortgage debt prior to retirement regardless of the cost of money. In fact, she goes even further, advising her clients to delay retirement entirely until they’ve eliminated their mortgage debt so they can enter their nonworking years with zero liabilities to service.
For clients who already have mortgages financed within the past few years at lower interest rates, Steele warns them to do the math before trying to capitalize on the spread.
“We are always careful to look at the post-tax rate of the instrument being considered and explain the benefit or lack thereof to the client,” she said. “For instance, one-year T-bills had a yield of close to 4% yesterday, but that is a pre-tax figure. For a client with a mortgage at 3.5%, it may not make sense once taxes are considered.”
If clients are purchasing a home for the first time, Steele recommends they carefully consider how long they intend to live in that home to evaluate the best mortgage option. That said, such clients generally have not started thinking about retirement yet in her experience.
However, if individuals are more susceptible to mortgage-rate fluctuations, such as those with adjustable-rate mortgages who also are nearing retirement age, Steele said they should absolutely consider the affordability of their debt prior to committing to a retirement date.
“Again, for our clients, debt service is one of the first conversations we have and make eliminating debt a top priority before retirement,” she said.
DO NOTHING — OR MAYBE DO SOMETHING
Ashley Bete, CEO and chief investment officer with Leap Analytics, doesn’t recommend homeowners with low-rate mortgages make significant changes to their loans. He also advises clients against overpaying for reverse mortgages or taking out a significant home equity line of credit to raise capital in retirement.
Still, with residential real estate prices up so much in recent years, Bete is not averse to suggesting a home equity agreement if clients know they’ll be selling their house in the next 10 years and are looking to access cash for an immediate need.
“With a HEA, a client can extract 5% to 20% of the present value of the property in exchange for a predetermined percentage of the future value over the next 10 years or until they refinance or sell the property,” Bete said. “Homeowners make no monthly payments throughout the HEA. And when they eventually sell the property, the HEA investor’s share of any gains is likely fully tax-deductible as capital losses to most homeowners against capital gains from the sale.”
TAKE STOCK, YOUNG PEOPLE
Retirees may not feel the brunt of increasing rates directly in their daily lives, as it’s rare for those in the later stages of life to bring on new secured debt. Younger professionals in the acclimation period of their retirement plans, however, tend to feel the pinch of rising rates more acutely as they are more likely to be borrowing for major purchases.
Of course that doesn’t mean they lack the chance to pick up a few bargains, said Brian Baker of Baker Financial Group.
“Equity markets typically underperform during periods of rising rates as borrowing costs increase and corporate earnings decrease,” Baker said. “While this may result in equity portfolio value decreases, lower entry points for any new contributions are presented. During times like these, it is especially important for young people to continue to live within their budget, pay themselves first, and maintain their focus on the longer-term goals.”
Dom Pullano, financial adviser with PCM Associated at Kingswood US, is telling clients to “keep their options open” and maintain their mortgage if it’s locked in below 4%. For clients holding variable loans, though, the breaking of the 6% barrier necessitates a total portfolio reassessment, which may include participation in the equity market.
“Income issues are still under pressure, so I recommend reviewing their retirement portfolio for total return,” Pullano said. “Equity portfolios with a rising dividend stream can, over time, help improve your income gap and offset the current high interest rates.”
PUT IT IN REVERSE — OR DOUBLE DOWN
With interest rates on the rise and home prices still elevated, many borrowers are looking to strategically employ reverse mortgages to pay off not just their mortgage, but other high-interest debt like credit cards as well.
“Tapping home equity can protect a borrower’s cash reserves while providing potential tax deduction benefits. And if a borrower purchased a home years ago, they may be poised to use their record levels of home equity to their advantage, even in the current rate environment,” said David Peskin, president of Reverse Mortgage Funding, adding that retirees and pre-retirees should confer with a financial adviser before making any changes to their retirement plan or portfolio.
“Increasing their sense of financial security and ideally, fulfilling the lifestyle they set out to enjoy in their golden years, is the goal for retirees,” Peskin said. “Fortunately, many are able to achieve this through utilizing their home equity to improve their cash flow.”
Another idea is to use the funds generated by a reverse mortgage to buy more properties.
Nicole Rueth, senior vice president at the Rueth Team, views a client’s primary home as a “terrible” investment, saying it “creates stability and security, but it is limited in its return.” In her opinion, capitalizing on the generous equity all homeowners have been gifted, along with the rise in rents, allows a homeowner to multiply those returns.
“Instead of one home, [they could have] possibly two or three all gaining value with appreciation and principal reduction,” Rueth said. “This can be even more advantageous if you are over 62 and refinance your home into a reverse mortgage, stop making a primary home mortgage payment, and use the equity to purchase one or two investment properties.”
Finally, John Robinson of Financial Planning Hawaii sees rising mortgage rates as a way for cash buyers to cash in. While mortgage rates may make home buying much more difficult for younger buyers, Robinson believes there are opportunities for consumers who are at or near retirement and looking to downsize.
“The greatest benefit from downsizing in the current environment may be conferred on consumers whose homes have appreciated to near the maximum capital gains exclusion amount, which is $250,000 for single homeowners and $500,000 for couples,” Robinson said. “The ability to pocket the gains tax-free is a big win.”
