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Are you still financing a home as a retiree or soon-to-be retiree but worried about having enough available cash to pay off your mortgage? Consider using an annuity to repay your home loan debt.
This strategy ensures that you’ll have a reliable stream of money in place to pay your loan punctually every month. But it can tie up your funds and may leave you financially vulnerable in other areas.
Take the time to parse through how annuities work, if this is the right tactic for paying your mortgage loan, and other options to consider.
An annuity is a financial product offered by many insurance companies that provides payments over a set duration to the holder of the annuity (annuitant), serving as a contractual agreement between the two parties. To fund the annuity, you commit to either paying a lump sum or regular premiums to the insurance company in exchange for periodic future payments.
Annuities frequently serve as a viable retirement income strategy because they provide a consistent income stream during retirement years. They facilitate tax-deferred growth on earnings, wherein invested funds accumulate without tax implications until withdrawals commence.
However, annuities may charge associated fees and expenses, and you may have to pay penalties for early withdrawals.
The two main types of annuities are:
- Immediate annuities: Here, you make a one-time lump sum payment to the insurance company and promptly receive payments, which can either be fixed (with predetermined amounts) or variable (contingent upon the performance of underlying investments). “An immediate annuity will begin payouts within 12 months,” explains Certified Financial Planner Stephen Kates with Annuity.org.
- Deferred annuities: This involves making payments over an extended period, either as a lump sum or via periodic premiums. These payments accrue with interest until you opt to begin receiving payouts, typically at retirement and at least 12 months from the purchase date. Deferred annuities also offer the option of fixed or variable payments.
“Imagine an annuity as your financial companion – a pact made with an insurance company. It involves contributing dollars in exchange for a commitment to provide a consistent income stream, either for a predetermined period or throughout your life,” says Karina Newman, a real estate investor and financial expert. “Having guaranteed income like this is akin to having a financial friend that will deliver a fixed amount regularly, offering a sense of financial security.”
How an annuity can help pay your mortgage during retirement
Consider that principal and interest charges for a fixed-rate mortgage loan are predictable and consistent, making them easy to plan for and cover using an annuity payment.
For example, let’s say you have seven years remaining on your mortgage, with a $100,000 outstanding balance due at a 4% fixed interest rate. Assume your property taxes and homeowners insurance will remain the same at about $200 per month.
Your total monthly mortgage payment, including principal, interest, taxes, and insurance, is $1,394. While you don’t have enough money outside of your retirement accounts to pay your loan in full today, you can use a retirement annuity to structure income payments and ensure your mortgage will be covered, according to Kates.
“Here, you could choose to cover your mortgage payment using a 10-year period immediate annuity that pays $1,400 monthly. The upfront premium would likely be $138,185 with a minimum expected payout of $168,000 over the 10 years. If you pass away before the 10 years are up, your beneficiaries will receive the remaining payments,” he says, although some annuities limit or prevent payouts from being passed on to heirs after you die.
Or perhaps you don’t need to cover the entire monthly mortgage bill. Suppose you recently retired and have a monthly mortgage payment of $1,000. You could purchase a deferred annuity that pays out $500 per month.
“This annuity would cover half of your monthly mortgage payment. You would still be responsible for the remaining $500 per month unless you choose an annuity with a higher monthly payout,” says Veronica Fernandez, founder/CEO of Secure Senior Benefits.
» MORE: See today’s refinance rates
The pros and cons of using an annuity to pay your mortgage
Annuities offer a range of benefits to retirees that can provide peace of mind, including:
- Stable income. “Annuities provide a consistent and predictable stream of income, which could be crucial for meeting regular expenses like mortgage payments,” Fernandez continues.
- Financial planning. “Knowing the exact amount you will receive each month helps in budgeting and financial planning, reducing uncertainty in your retirement years,” she adds.
- Inflation protection. Certain annuities provide inflation-adjusted payouts, which can maintain the income’s purchasing power over time.
- Longevity risk mitigation. “Annuities can offer lifetime payouts, ensuring you do not outlive your resources, which is a significant concern for many retirees,” says Fernandez.
Knowing you’ll have your mortgage expense covered, you can more confidently spend your remaining retirement dollars on other things you choose without having to fret about your home loan.
On the other hand, committing to an annuity may not be in your best long-term financial interest.
“Annuities typically lock in your capital, reducing liquidity. This can be problematic if you need access to a large sum of money unexpectedly,” Fernandez cautions. “Also, annuities typically come with various fees and expenses, including management fees or surrender charges. Fixed annuities are sensitive to interest rate changes, too. Purchasing an annuity in a low-interest rate environment might result in lower returns compared to other investment options.”
Furthermore, once you lock in your annuity, you usually aren’t allowed to change the payout structure or terms, which means you’ll find it difficult to adjust if financial changes are needed.
“The biggest disadvantage is that an annuity will tie up your money into a contract that you cannot get out of. If you discover that you need that money for an emergency, you won’t be able to access it. You are essentially trading certainty for flexibility,” says Kates.
Good candidates for using an annuity for mortgage payments
Worthy prospects who should ponder an annuity for mortgage-paying purposes include those with an adequate emergency fund, who do not have enough pension or Social Security income to cover their essential expenses, and who are comfortable investing their remaining savings more aggressively to provide longer-term growth that makes up for the dollars paid to the insurance company, per Kates.
“Those with a clear understanding of their retirement expenses and a preference for stable, predictable income are good candidates,” agrees Shawn Plummer, CEO of The Annuity Expert.
You might want to steer clear of this strategy, however, if you anticipate your home-related expenses increasing substantially over time, plan on moving or selling your property within a few years, already have sufficient guaranteed income from other sources to cover your essential expenses, or lack sufficient savings either in after-tax or retirement accounts to pay for expenses and emergencies.
The right annuity for you
Ask Plummer and he’ll tell you that the ideal annuity type for a retiree seeking to pay their mortgage with these funds is a fixed immediate annuity.
“Here, you know what payout to expect and can budget accordingly. This stability is crucial for meeting fixed expenses like a mortgage,” he says.
“I would choose a fixed immediate income annuity that either lasts for a set period, such as 10 years or your lifetime,” he says. Even if your mortgage will be paid off sooner than that, “the added years of guaranteed income will offer some additional income stability.”
Starting the process
Follow these steps, recommended by Kates, to choosing an annuity:
- Calculate your mortgage payment or the amount of the payment you want to cover monthly.
- Shop around among different companies for annuity contracts that offer you coverage for the payment amount you need.
- Consider whether your savings are adequate to purchase an annuity and cover your remaining expenses. “Working with a financial advisor from the beginning is helpful, but make sure you are planning for your entire lifestyle and not just the mortgage,” Kates advises.
- Purchase the annuity that best fits your needs. Be sure the payment is made directly to you and not the mortgage lender so that you have the choice of how the payment will be used in the future.
Alternatives to consider
An annuity is certainly not your only option if you want to ensure ample extra funds to pay your monthly mortgage in retirement.
“Try paying extra toward your mortgage principal, which can reduce the overall interest owed and shorten the length of the mortgage term. The earlier you do this, the more of an impact it will have on your interest owed,” suggests Kates.
A refinance may be a good option, too, assuming you can lock in a fixed interest rate lower than your current rate. This will decrease your payment or enable you to shorten your loan term.
“Other alternatives include a reverse mortgage, which can offer more liquidity if you have enough equity accrued, or investing in a diversified portfolio for potentially higher returns – albeit with greater risk,” says Fernandez. “Or, consider renting out a portion of your home or investing in rental properties, which can provide an additional stream of income to cover your mortgage costs.”
Instead, you may want to downsize to a smaller and more affordable home, which can free up equity and decrease or eliminate mortgage payments, helping to stretch your retirement savings even further.
“Recasting your current mortgage is another choice, which allows you to pay a lump sum to the lender who will then re-amortize your loan with a new lower principal amount,” adds Kates.