SMART DEBT MANAGEMENT FOR RETIREMENT

By Larry Washington
Chairman and CEO
Merrill Lynch Credit Corporation

One factor that has helped propel the real estate boom and caused nationwide median home prices to nearly double since 2000 is the increasing number of homeowners willing to carry debt. Much of it is mortgage debt that has been taken on to upgrade to a more expensive home or to purchase rental or vacation properties. Mortgage obligations as a percentage of disposable personal income topped 10.5% in the second quarter of 2005; and since 2000, total outstanding debt has nearly doubled to $12 trillion.

Mounting debt levels are also impacting retirement planning. In fact, the percentage of households headed by people between the ages of 65 and 74 who are carrying home mortgage debt continues to climb. Many of these homeowners are approaching retirement with the realization that they may still carry sizable mortgage balances well beyond the end of their working years.

While conventional wisdom holds that it is generally better for retirees to be free from sizeable monthly expenses such as mortgage payments, some homeowners may find it more advantageous to keep paying a loan into retirement. That is particularly true if eliminating the mortgage means jeopardizing other savings goals or restricting liquidity. Fortunately for retired and soon-to-be-retired homeowners carrying large mortgage balances, there are several strategies that can help them keep their retirement planning on track while making mortgage debt more manageable during their golden years.

Choices for Retirement Planning

“Burning the mortgage” still makes good sense for many people who can do so without sacrificing savings or depleting too much of their cash. And paying off a mortgage may provide homeowners a return on their “investment” equal to the interest rate on the loan that is paid off.

However, homeowners carrying a mortgage with an extremely low long-term fixed rate may find it more advantageous to use their cash for other needs rather than rushing to pay off a low cost (and often tax-advantaged) source of funds. Low mortgage payments free up cash flow for other priorities, such as retirement and long-term care. Generally, if the expected rate of return on your investments exceeds the interest rate on your debt and you are willing to accept some volatility over a holding period, the greater potential benefits of investing may outweigh the risk of carrying debt.

One important caveat: Investors at retirement age should generally be weighted heavily in conservative and fixed-income investments; but to obtain the historically higher returns from stocks, they may be tempted to pursue riskier securities that are subject to significant volatility and price risk. That approach could lead to the unenviable position of losing capital and holding a mortgage.

A sensible compromise might be to fund all of your retirement accounts—such as IRAs and 401(k) plans—first, along with any special needs savings accounts, and then use any remaining funds to pay down mortgage debt.

Changing Attitudes Toward Debt

A key difference between the 76 million baby boomers hitting retirement age over the next 20 years and the previous generation of retirees is their view of debt. While boomers may carry more debt on average than their parents did, they are also wealthier due in large part to the equity they have built up in their homes, particularly, over the past five years.

Thus, in today’s upwardly mobile society, not everyone is on track to pay off their mortgage before retirement. For example, boomers who must tap into existing retirement accounts – and pay penalties and taxes to free up funds to pay off their home loan – are likely better off continuing loan payments. Even those with the wherewithal to pay off their mortgage easily may not wish to do so if the interest rate is less than their expected return from investments.

In addition, there are many specialized types of mortgages, which can provide flexibility in monthly payments. That financial latitude may be advantageous both for individuals approaching retirement, as well as for those who enter their non-working years with uncertain cash flow.

Equity Financing Options

Baby boomers as a group are also big buyers of vacation and investment properties. In many cases, they have funded these purchases or made down payments on them with equity built up in their primary residences. During the last five years, many of these vacation homes have appreciated to two or three times their original value—thus creating substantial amounts of new equity. A home equity line of credit (HELOC) can be a vital tool for homeowners to tap into any increased equity of their property. Home equity financing can be an attractive alternative to liquidating investments, and the interest on a home equity loan is potentially tax-deductible. Plus, because you draw down funds only when you need them, you pay interest only on the amount you borrow. HELOCs can help you meet a range of financing needs, including:

• Home improvements that can increase the value of your home.
  
• Periodic tuition bills and other education-related expenses, such as housing and school activity costs.
  
• Debt consolidation, which can help lower the cost of your overall credit by consolidating high cost credit cards and unsecured personal loans.
  

Choosing the right mortgage for your particular needs means finding one that is in sync with your retirement, tax minimization, educational savings and estate planning strategies. In addition, the right mortgage can potentially improve your cash flow, free up resources for other financial goals and could increase your potential tax deductions.

Merrill Lynch does not provide tax advice. Please consult your tax advisor regarding the deductibility of mortgage interest. Interest expense may not be deductible for all taxpayers.

All residential mortgage programs are offered and funded by Merrill Lynch Credit Corporation ("MLCC"), 4802 Deer Lake Drive East, Jacksonville, FL 32246-6484; toll-free telephone: 800-854-7154. AZ License BK-10071; CA Real Estate Broker’s License 00831469 - CA Department of Real Estate (916) 227-0931; IL Residential Mortgage Licensee; MA Mortgage Lender License ML1436 & ML2078; Licensed by the New Hampshire Banking Department; Licensed by the NJ Department of Banking and Insurance; RI Licensed Lender. This is not an offer to enter into a rate lock-in agreement under Minnesota law. An offer may only be made in writing. MLCC is a primary and secondary mortgage lender.

© 2005, Merrill Lynch, Pierce, Fenner & Smith Incorporated. Member, Securities Investor Protection Corporation (SIPC).

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