This post looks at the decision to sell a house and move or payoff the mortgage. Decision day is 12 years after purchasing the home. The decision is analyzed for a person in a 15year FRM and for a person in a 30year FRM. It is assumed the person has no liquid assets and that any mortgage payoff occurs from fully taxed disbursements from a 401(k) plan.
The Issue: Your client is purchasing a house. She is 12 years away from retirement. At retirement she will either sell the house, take equity and move or she will pay off the mortgage and remain in the house.
There are costs associated with moving to a new home, which impact the amount of house equity that your client will receive if she decides to sell and move.
There are costs associated with moving to a new home, which impact the amount of house equity that your client will receive if she decides to sell and move.
Your client
has no liquid assets outside her 401(k) plan.
Hence, any mortgage payoff would occur with 401(k) disbursements which, are
fully taxed at ordinary income tax rates.
Build a
spread sheet that provides estimates of available house equity and mortgage
payout for both a 15year and 30year fixed rate mortgage. Design the spread
sheet so it is easily modified for different financial assumptions.
Comment on
advantages and disadvantages of the different mortgage terms for this older
buyer.
Your Client’s Information: Information on the house purchase is presented in the table
below.
The 30year FRM analysis is on the left and the 15year FRM analysis is on the right.
The mortgage interest rate for the the 15year FRM is 3.3 percent 0.7 percentage points less than the interest rate on the 30year FRM. This differential is not atypical of the market.
The 30year FRM analysis is on the left and the 15year FRM analysis is on the right.
The mortgage interest rate for the the 15year FRM is 3.3 percent 0.7 percentage points less than the interest rate on the 30year FRM. This differential is not atypical of the market.
Assumptions and Input for
Mortgage Choice Question


Purchase Price of House

$500,000

$500,000

Down payment percentage

0.9

0.9

Initial Loan Balance

$450,000

$450,000

Mortgage Term

30

15

House appreciation rate
assumption

3.0%

3.0%

Mortgage Interest Rate

4.0%

3.3%

Years until retirement & change in mortgage status

12.0

12.0

Cost of selling and moving to a new home as % of house value
assumption

9.0%

9.0%

Tax Rate on Disbursements from 401(K) Plan
assumption

30.0%

30.0%

The only
difference in the two scenarios is the mortgage term – 30 years versus 15
years.
Forecasted House Equity and Mortgage
Payoff Amounts:
The bottom
two rows of the table provide information on forecasted house equity after
selling and moving costs and forecasted mortgage payoff amounts for your client
for a 30year and 15year mortgage.
House Equity and Mortgage Payoff Calculations


30year
FRM

15year
FRM


Expected house value at sale date

$712,880

$712,880

Mortgage Payment

($2,148.37)

($3,172.96)

Mortgage Balance on Date of House Sale

($330,417.79)

($108,612.27)

House Equity after Selling and Moving Costs

$318,303

$540,109

Forecasted Amount Needed to Retire Mortgage Including Taxes on
401(k) Disbursements

$472,025

$155,160

Discussion of Results:
The older
worker who brings a larger mortgage balance into retirement is almost certainly
going to have to sell her house and move.
One of the
factors driving the results presented here is the person pays off the mortgage
from 401(k) funds, which are fully taxed at ordinary income tax rates.
The use of
a 15year mortgage substantially decreases the amount needed to pay off the
mortgage.
Appendix: Describing the House
Equity and Mortgage Payoff Calculations:
The description of the documented spread sheet for the available house equity calculation and the mortgage payoff calculation are available at the link below.
Go Here:
http://www.dailymathproblem.com/2017/09/howtocalculatehouseequityand.html
Concluding Thoughts The use of a 15year FRM substantially
increases the probability your client will be able to stay in her home after
retirement.
However,
the higher payment on the 15year FRM will require your client to reduce
contributions to her 401(k) plan. Spread sheets which examine issues pertaining
to 401(k) growth will be available shortly.
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