Monday, June 17, 2019

House Equity and Mortgage Payoff Spread Sheet


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 15-year FRM and for a person in a 30-year 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.   

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 15-year and 30-year 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 30-year FRM analysis is on the left and the 15-year FRM analysis is on the right.

The mortgage interest rate for the the 15-year FRM is 3.3 percent 0.7 percentage points less than the interest rate on the 30-year 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 30-year and 15-year mortgage.


House Equity and Mortgage Payoff Calculations

30-year
FRM
15-year
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 15-year 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/how-to-calculate-house-equity-and.html


Concluding Thoughts   The use of a 15-year FRM substantially increases the probability your client will be able to stay in her home after retirement.


However, the higher payment on the 15-year 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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