Safe withdrawal rate when you have a mortgage?

[sophie]

I was figuring to calculate expenses for the mortgage separately.  That is, the 4% SWR applies only to non-mortgage expenses.  To this figure add the balance of the mortgage at retirement.

If your mortgage rate exceeds 4%, you should be able to just pay it off upon retirement.  If it's less than 4% (as in Libertarian666's case), you can decide to carry it, as the mortgage balance would theoretically generate more than enough $$ to carry the mortgage interest.

Personally, I favor the pay it off on retirement option, if my retirement income takes me down at least one tax bracket.

Hope that's useful.

[Dieter]

Just don't forget to factor in the money to pay taxes on the money used to pay the mortgage (sorry if discussed.)

Not an issue if from Roth, but elsewhere.... And any impact on Social Security.

[jason]

The safe withdrawal rate is calculated from your liquid investments that you can sell 4% of every year to pay the bills.  You can't do that with your house, so it doesn't count.  Your home equity does count towards your net worth, but that's a different measure that is unrelated to SWRs.

Just looking at the average return vs the interest rate, a 30 year fixed rate mortgage makes a lot of sense these days for making more money over time provided you wait long enough.  I admit my opinion on mortgages is based on more than just the math for maximizing returns (which is nice but not the be-all-end-all when you already have plenty of money).  For example, I found my mortgage bank to be borderline deceptive at times (a form of counter-party risk), and I have a personal preference at this point in my life for prioritizing minimizing uncertainty over maximizing returns. 

And FWIW, one of the reasons markets don't stress me out is that -- without a mortgage -- my expenses are so darn low that even in a poor investment year covering them completely with a little part time work is really easy.  That flexibility is nice and makes my retirement finances very stress-free.  Everyone is different, though, and depending on your situation you may prefer more invested assets (with an offsetting mortgage) to provide the same peace of mind.

I'm not sure I completely agree with the idea that equity in real estate adds nothing to your SWR. While you can't sell a piece of your home every year, a home is a fairly liquid asset. If I live in a 500k house today that I have 400k equity in, I can downsize to a 200k house and pocket the difference. That has to have some value in terms of SWR. I guess it comes down to how willing one is to sell/downsize. I think it's like owning art or investing in a private equity fund. It has value, but it falls under the VP. I guess the big question is what the SWR is for one's VP, which is probably very hard to ascertain.

[Pointedstick]

I'm not sure I completely agree with the idea that equity in real estate adds nothing to your SWR. While you can't sell a piece of your home every year, a home is a fairly liquid asset. If I live in a 500k house today that I have 400k equity in, I can downsize to a 200k house and pocket the difference. That has to have some value in terms of SWR. I guess it comes down to how willing one is to sell/downsize. I think it's like owning art or investing in a private equity fund. It has value, but it falls under the VP. I guess the big question is what the SWR is for one's VP, which is probably very hard to ascertain.

That's certainly less liquid than hitting sell on your brokerage account's online interface. It's less liquid even than going down to the coin shop to sell some gold. I guess the question is "how illiquid is illiquid?" I personally see a house as a very illiquid asset. Selling a house and moving is a big undertaking with extremely substantial time and transaction costs. It involves potentially separating yourself from location-based relationships and conveniences. It may entail buying new furniture and probably the new house has a bunch of little things you want to change or correct that you won't know about until you're there. In addition, if you are moving between houses in the same real estate market, downsizing represents moving into a smaller house, a worse house, or a worse neighborhood. In a lot of urban markets, a 500k house is about the minimum for a livable neighborhood, and going down to 200k means you're in close proximity to a ghetto, a bunch of crack houses, or other problems. And there may not be a lot of room to downsize if you're already living modestly.

In my own housing market, there's not much room to do this at all. I bought my house--a fixer-upper--for a little less than 100k. Right now it's worth maybe 130k, I dunno. That's probably wishful thinking. If I wanted to transform my sweat equity into cash, I'd have to find a livable place for 100k or less, and based on my experience doing this last time, it's not an option. A livable 70k to 100k house in this market puts you either 15 miles away from anything or in the part of Albuquerque that's nicknamed "The Warzone." No thanks.

[lordmetroid]

If you got a house worth anything you can simply sell, pocket the who profit and move into a rental apartment. Maybe a one room flat. That is a huge downsizing and now your portfolio is worth several 100K more in a relative small amount of time.

The yield that the profit will generate might be larger than the relative small rent you have to pay for your single room.

[Libertarian666]

If you got a house worth anything you can simply sell, pocket the who profit and move into a rental apartment. Maybe a one room flat. That is a huge downsizing and now your portfolio is worth several 100K more in a relative small amount of time.

The yield that the profit will generate might be larger than the relative small rent you have to pay for your single room.

Warning: don't try this if you are married. Divorce is very expensive.

[Pointedstick]

Yeah that's only a practical option if you're single without kids. But if that's your situation, then living like that can indeed be a good financial move, and it'll give you a lot of flexibility, too.

[Tyler]

Yeah that's only a practical option if you're single without kids. But if that's your situation, then living like that can indeed be a good financial move, and it'll give you a lot of flexibility, too.

Yep.

Safe withdrawal rates are simply back-tested measures of sustainability for passive investments that you are depending on to pay the bills.  They're just one piece of the retirement puzzle, and are not all-inclusive of every item of financial value that you have access to.  They don't account for things you own that aren't liquid enough to pay your water bill every month (like home equity, cars, land, etc), they don't account for things you actively manage (like downsizing your house, day trading a VP, or managing a bunch of rentals), and they don't directly* account for non-investment income sources (like social security, annuities, or part time work). 

(*) Other income reduces your dependency on your investment income, but does not actually affect the calculated SWR for your investments.

That certainly doesn't make those other things worthless, and there are many ways to improve your retirement picture beyond simply massaging the SWR for your investments.  A bit of smart money management will beat purely passive SWRs every time. 

[BearBones]

I do not think that a mortgage should be compared to the average back tested performance of your entire investment portfolio.

Paying off a mortgage is equivalent to a guaranteed and safe investment return of that rate (post tax equivalent). As close as we can get to a guaranteed and safe return is from short term treasuries. So, especially in the current economic environment, I'd rather be using cash to pay off a mortgage rather than park it in the second most guaranteed/safe investment that is paying well less than 1%.

[Libertarian666]

I do not think that a mortgage should be compared to the average back tested performance of your entire investment portfolio.

Paying off a mortgage is equivalent to a guaranteed and safe investment return of that rate (post tax equivalent). As close as we can get to a guaranteed and safe return is from short term treasuries. So, especially in the current economic environment, I'd rather be using cash to pay off a mortgage rather than park it in the second most guaranteed/safe investment that is paying well less than 1%.

There's nothing wrong with that, but in my case I get almost free inflation protection by owing more on my mortgage than my holding of USD.