If you’ve spent much time on this site, you know that I’ve taken aim at the assumption that homeownership is good for everyone. It’s not that I think owning a home is bad, but more that I don’t think it’s right for everyone. In addition, I think that the advancement of- and unquestioned belief in- universal homeownership was one of the root causes of the real estate and mortgage meltdown.
Today I’d like to zero in on homeownership as it relates to retirees, and by extension, to retirement planning. I’m going to risk committing a heresy to make the case that many would be better off renting in retirement.
Why might some retirees be better off renting?
Carrying a mortgage into retirement
The conventional wisdom is that you should have a home of your own and no mortgage on it when you retire–so far, so good. But what if your house won’t be paid off before retirement? Or what if you’re already retired and you still have a mortgage?
For many people, that’s the reality. More than half of retirees were carrying mortgage debt in 2009, which was double the percentage just two years earlier. Apparently a generation raised with debt as a traveling companion doesn’t feel compelled to eliminate it in retirement as previous waves of retirees have.
For the vast majority of people, being able to retire at all will require a reduction in living expenses; since a mortgage is typically the single largest expense, carrying it into retirement will be like dragging an anchor from the past.
It begs the question: what’s the difference between paying a mortgage, and paying rent? I’d argue that the answer is “not much”. When you’re a tenant, you pay rent that enables you to live in the property. When you pay a mortgage, you pay “rent”—a.k.a., interest—on the money you owe that enables you to live in the property.
So if it’s a wash whether you rent or own with a mortgage, why not own? Read on.
The tax benefits of home ownership may evaporate
Tax breaks are one of the major reasons driving people to own homes, but for many seniors that benefit diminishes or even disappears completely. Since the income tax is progressive (tax rates rise with higher income) the homeowner benefit declines with the lower income that retirement usually brings.
Not only is income usually lower, but some of it also escapes taxation altogether. Social Security income, for example, is only partially taxable for federal taxes while states exempt it completely. And most states offer generous income exclusions for retirees. Here in Georgia, seniors get a $35,000 exemption for “other retirement income”—and that’s per person.
Lower income/less taxable income means less homeownership tax benefit. For many retirees, there will be no more tax benefit to owning than with renting.
Taxes can also be a complicated consideration, and will largely depend on where you live. For example, in Canada, you can get a up to $30,000 for an “HST Rebate” if you build a new home, purchase a new home as a principal residence (or investment property), or substantially renovate a home – as long as it has been done within the past two years. You can get details on the rebate through a chartered accounting firm, such as Toronto-based Rebate4U. Since the HST tax itself if only a few years old – and since it varies by province – the details on how it works, and especially on the rebate, are complicated. Don’t try to go this one alone.
A renter doesn’t have to worry about repairs and maintenance
If you rent, you don’t have to make repairs. New roof–$5000, $7000, $10,000—not your problem. New furnace—$5000, $7000, $10,000—again, not your problem. These expenses, often completely ignored in the homeownership equation, can be a budget buster for retirees on a fixed income.
And how about maintenance? Maintaining the lawn, trimming hedges, raking leaves, shoveling snow—the homeowner has all of these responsibilities, the renter has none. For the retiree, or the person planning for retirement, these are more than just minor ongoing responsibilities.
Who will maintain your property if you’re unable to? Many retirees like to travel; and as much as we may not want to think about this, many have or will develop health issues that will make routine maintenance undesirable or even impossible. Now you’re looking at paying someone else to do what you can’t, and another expense is added to the budget. A retiree who rents doesn’t have this issue.
Even if you have no mortgage, you’re never really “rent free”
It’s sometimes said that people who have paid off their homes live “rent free”, but as popular as that notion may be, is it even true?
Not entirely – and maybe not at all.
We’ve already discussed repairs and maintenance as an ongoing cost of owning a home, but you’ll also have real estate taxes, homeowners insurance and possibly home owner’s association dues. In some areas of the country, real estate taxes have gotten so high that the monthly expense comes close to what it would cost to rent an apartment. None of these expenses will disappear because you paid off your mortgage.
The idea that you’ll ever truly be rent free is virtually a myth, and we haven’t even gotten to another significant “expense” involved in homeownership that rarely gets much attention…
A house is a capital trap, and one that’s owned free and clear has even more money tied up in it. While not having a mortgage payment is a substantial advantage to a retiree, much of the benefit is lost when we consider what else could be done with the money if it weren’t tied up in the house, also known as the opportunity cost.
Earning income on the money to generate an additional cash flow is one opportunity cost. This is a more obvious issue when interest rates are higher than they are now. Since interest rates on savings vehicles are at historic lows, it doesn’t seem to be much of a factor. But low interest rates have caused a real issue for retirees in this regard, creating a very real opportunity cost from another direction.
With interest rates on savings hovering in the low single digits, access to principal has become more important to retirees than the income it generates. It is for this reason that reverse mortgages have become so popular—people need the cash that’s tied up in their homes. And—ironically—how much of that cash is being borrowed out to maintain and make needed repairs to the home itself?
In a higher rate environment, a retiree could rely on the cash flow from the income on his investments—now he may need to draw down the investment itself to survive.
Is renting in retirement right for YOU?
Is renting the better option for all retirees? No, not for all—but then neither is homeownership. Each retiree, or prospective retiree, has to consider his or her housing situation in light of personal circumstances, and not rely on general assumptions or on “conventional wisdom”.
When might you be better off renting than owning in retirement?
- If you have few investments apart from the equity in your home
- If the necessity of taking a reverse mortgage is more than a remote possibility
- If your current house payment—with or without a mortgage—is higher than prevailing rents in your area
- If you’ll be carrying a mortgage into retirement that won’t be paid off any time soon
- When there’s a distinct possibility that you may need to make a move shortly after retirement; this could be for health reasons, to follow your children, or because now that you’re retired you don’t want to live in any one place
- When health problems or a desire to travel necessitate paying others to maintain your home
- When selling your home will mean the difference between a comfortable retirement and a life of struggle
- When you’re “over-housed”—the 4000 square foot home you raised your family in is three times more space than you need now and you’re tired of paying for what you aren’t using
- When there’s so much equity in your home that freeing it up will open up some…exciting life opportunities
Consider which path is best for you in light of the above questions—you may be surprised to find that renting is the better opportunity for you in your retirement years.
Fortunately the tax code offers favorable treatment if you want to sell your house and cash out. The IRS allows a one time exclusion from tax on the gain on the sale of your primary residence of up to $250,000 ($500,000 if married, filing joint) that will enable most people to liquidate their homes with little or no tax consequences.
Have you ever considered renting as part of your retirement strategy? Do you see any downsides? Are there other reasons to rent that I haven’t listed?