Tarhill Photos Inc./CORBIS
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Flight Plan
By Eric Tyson, September & October 2006
Should these would-be snowbirds pay off their mortgages before heading south?
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Indiana residents Lynn and Robert Modell* always figured they'd be snowbirds in retirement, migrating south before the first frost. To fulfill that dream, eight years ago they bought a condominium in Florida, renting it out year-round to make it pay for itself. But last winter—after Robert, 58, retired and Lynn, 49, went on disability—instead of heading south they stayed put, unsure they could afford to live their dream.
The Problem
Carrying mortgages on their two properties—they owe $68,000 on the condominium and $75,000 on the house—gives the couple pause. "Should we tap our savings and pay off the condo?" asks Robert. "Should we keep renting it out and apply the money toward paying down our home mortgage? At what point can we start traveling?"
With $114,000 in savings outside of real estate, the Modells have a cushion, and they are adding $1,300 monthly from pension and rental income. Paying off the condo in one fell swoop, however, would take most of that stash, leaving them just $46,000 in savings before paying any taxes owed from the sale of investments.
The Plan
While there's a sense of security in paying off any mortgage, it's important to weigh whether that money would go further in another investment. Given the low fixed interest rate on their home mortgage—4.6 percent, with nine years to go—they needn't be in a rush to clear that debt.
Letting their 7 percent condo loan ride would be all right, too, if they could be sure the earnings on their savings would handily beat that each year. But Lynn and Robert have their money in a low-interest credit union savings account and a conservative mix of stock and bond mutual funds. Their long-term annualized return isn't likely to exceed 7 percent even before subtracting taxes. That makes paying off the condo the better move.
They may not want to do it all at once, though, because of the potential tax bite from cashing in investments that have gained in value. In drawing on their savings, the Modells should minimize taxes by selling fund shares with the smallest unrealized capital gains. To stay in their 15 percent federal income tax bracket (which for 2006 applies to joint filers with adjusted incomes under $61,300; to single taxpayers, under $30,650), they should sell investments over a two- or three-year period. Consulting a tax adviser is in order here.
Retiring the mortgage over a few years also means the Modells needn't take all $68,000 from savings. Their $1,300 in surplus monthly income would bring more than $30,000 to the table in two years. If they want a Florida vacation in that time, they can always rent somebody else's place.
For the longer term, these young retirees owe it to themselves to get more for their money. They can more than double the yield of their credit union savings account with any number of money market mutual funds, which were recently yielding 4.7 percent. As for stock and bond funds, the Modells should get smart about fees. They paid more than 5 percent in sales charges to buy into several funds. Future investments should go into an array of no-load funds.
Eric Tyson, a former financial counselor, is the author of Personal Finance for Dummies (Wiley, 2003) and Mind Over Money (CDS Books, 2006).
*Names changed for privacy.
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