Pre-retirees: Don't use your home as an ATM

I've been helping people save and invest for more than two decades. In that time, I've come to understand that one of the best routes to financial independence is to enter into retirement without a mortgage.

Not only will you require substantially less income to survive, you'll also be subjecting yourself to significantly less stress.

But if this is all true, why do so many people reach retirement age and still carry a huge mortgage?

Alex Slobodkin | E+ | Getty Images

First, there's the oft-repeated myth that the tax deduction for home mortgages is a key building block of wealth. I'm all for tax deductions, but that tax deduction is allowed only when interest is paid by the homeowner. And the cost of the interest will always be greater than the tax savings.

Here's an example: Let's assume someone has a marginal tax rate of 35 percent and pays $10,000 per year in interest charges. A tax deduction can be taken for the interest paid, but the tax savings for the deduction is only $3,500, leaving the homeowner on the hook for the remaining $6,500.

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So technically, yes, the taxman received $3,500 less, but the homeowner is still poorer by that $6,500.

The second reason so many people retire with mortgages is that they've been convinced that their home's equity shouldn't just sit idle. I cringe when I hear or see ads encouraging people to raid the equity in their homes.

Using a home loan to take on debt is not unleashing equity—not even close. It's putting yourself into debt and holding your home hostage as collateral.

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The sad truth is that people squander the equity in their homes to buy all sorts of unnecessary things. While some borrow to finance other investments, the majority do so to support their lifestyles.

I've seen people who have lived in the same home for 30 years and hit retirement with a home mortgage two or three times larger than what they originally paid for their home.

A fact so many people seem unwilling or unable to understand is that a home is not an ATM.

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You can't just "withdraw" equity like you can your savings. Equity isn't real—until you sell your house. It's merely a perception of current value. So the only way to monetize equity is to either sell your home or take on additional debt—and the interest on the loan that goes with it.

A third reason so many retirees have mortgages is that, as interest rates have declined these past 30 years, people have refinanced to take advantage of the lower rates.

Starting all over

There is a time and a place for refinancing, but by doing so, many people just end up extending the balances and durations of their loans.

That's because there are only three things that happen when people refinance, and two of them are bad: First, they may pull a little cash out to pay off other debt. Then, they borrow to buy stuff they may not need, and finally, they wind up with a fresh 30-year amortization period.

So even though they might have already lived in the home for 20 years, they may still have 30 years left on the mortgage.

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One of the best ways to deal with a home mortgage is to match your home payoff date with your retirement date.

Forget just sending the minimum mortgage payment each month and dragging the loan out for 30 years. Instead, figure out how to have your home paid for by the time you retire (there are many free online tools to help you with this) and then be determined to do what's necessary to make that happen.

Here's an example: Let's say you're 52 years old and plan on retiring at age 66 and your home loan has 27 years remaining. If you make only the required mortgage payments, you'll be age 79 by the time your mortgage is retired. While in the short term you might appreciate the jump in your disposable income (when the lower mortgage payments commence), wouldn't it be better to have the advantage of significantly higher cash flow in your "younger" retirement years?

Because people who own their homes outright almost never lose them, it's just common sense to work to substantially lessen the expense of your post-work years by amortizing your mortgage payments so that they end when you retire.

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While I've covered some of the economics of it, what about the emotional benefits of a retirement without a mortgage?

Perhaps the most underrated aspect of paying off your home is the peace of mind it provides. People without mortgages tend to worry less about financial markets and the economy.

"With a little belt-tightening, a majority of Americans can indeed retire without a mortgage."

No matter what happens or how bad things get, they know they'll have a roof over their heads.

Of course, there are people who will simply not be able to pay their home off before they retire. Even though I believe that with a little belt-tightening, a majority of Americans can indeed retire without a mortgage, if it's simply not possible, then the goal should be to get the payments as low as possible once somebody is about to retire.

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This can either be done by refinancing or, in some cases, using a reverse mortgage to eliminate those payments altogether.

So the next time you're encouraged to pull cash out of your home, don't do it. It might make life a little easier right now, but you'll pay the price for it when you are older and want to start taking life a little easier.