Question: My husband and I are recently retired and living on a fixed pension and social security in Oakland, California. We own a townhouse with a $130,000 mortgage balance. We could probably sell it for at least $350,000 and net well over $200,000. Our plan is to sell it this year and move to the west coast of Florida where the weather is nice and the real estate is cheap. I think we should purchase our new home in Florida with the proceeds of our Oakland house and carry no mortgage because we are on a fixed income. My husband thinks we can afford a mortgage and that we should invest the equity instead. We don't have a lot of savings but we don't have big spending habits. Is there a rule of thumb as to how large of a mortgage retirees should take?

Answer: Lenders have income guidelines to help determine an affordable mortgage in relation to household income. But I never advise a borrower to determine their mortgage amount based on what the bank will lend. In my experience, most folks don't want a mortgage balance and monthly payment as high as most lenders will allow. Remember that the lender doesn't care about whether or not you can feed yourself at the end of the day -- it only cares about one thing: receiving your mortgage payment.

My guess is that you and your husband will find that a middle ground is best suited for your situation. What I mean is that it's probably not best to pay all cash, and it's not best to borrow as much as possible. Let's look at some of the issues that need to be considered before you and your husband make this decision.

First, you should consider affordability. Create a realistic monthly budget. Write down all your typical living expenses and try to be as realistic as possible. Review your checkbook register if it helps. The idea is to come up with a number (or a range) that includes all typical expenses. Be sure to include things such as estimated real estate taxes, hazard insurance and home maintenance costs in your budget.

Once you have an idea as to what your average monthly cash outflow is, compare it with your fixed income. This will help you determine how much of a mortgage payment, if any, you would comfortably be able to afford.

The second thing to consider is liquidity. You say you don't have a big savings account. Consider the drawbacks of having a very limited liquid savings account. Every household should have some cash in the bank for a rainy day. What would happen, for example, if you had a death or illness in the family and you had to fly across the country and stay in a hotel for week? If you don't have the cash to pay for such an expense, you run the risk of creating an ongoing credit card balance -- something that should be avoided like the plague.

Third, you should consider the tax issues. Undoubtedly, any mortgage interest you pay can be deducted on your income tax return. In essence, a tax deductible mortgage means the actual "cost-to-borrow" is less than your mortgage interest rate. For example, a six percent rate on a 30-year mortgage might equate to only five percent when you take into consideration the tax savings. A tax advisor would be able to help you on the issues of itemizing deductions on your return versus taking the standard deduction.

The last thing to do is compare the "cost-to-borrow" of a mortgage with the advantages of keeping your money and using it. If your after tax "cost-to-borrow" is only five percent, it's perfectly reasonable, although not guaranteed, to assume that money invested wisely will earn a considerable higher return than five percent over time. If you agree with this notion, the logical conclusion would be that an affordable mortgage balance would make some sense.

My advice is to first ascertain the amount of mortgage you can comfortably afford. Obtain the mortgage, stash away a bit of cash for emergencies and invest the rest wisely and conservatively.

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