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We have dealt with the concept of how much ‘house’ you can afford while you are still working, but what about when you ‘retire’ (young … very young!); that is the question posed by Ryan:

Regarding “the number”. I know you’ve touched on this briefly before, but when considering a multi-million dollar home to live in during retirement, would you suggest putting in a number to rent or to pay for a mortgage? If for a mortgage, do we assume a certain percentage down? And what kind of interest rate can we assume we’ll get in 10-20 years?

We basically have three options when acquiring a house:

1. Pay Cash

2. Take out a mortgage

3. Rent

The rental optionn is actually not so dumb in the high-end bracket, as rents tend to fall way behind house prices (hence mortgage payments) … just check out what you can rent for $40,000 – $50,000 a year compared to what the same level of mortgage payment (assuming a reasonable deposit of only 15% – 25%) will get you.

But, let’s also assume that your idea of ‘retirement’ isn’t to pack up and shift houses every couple of years so that leaves us with paying cash or financing.

The first thing to realize is the fundamental difference with buying a house when you are working and when you aren’t:

When you aren’t working all the money that you have is what you have already manufactured …

… so, all you are doing by mortgaging or paying cash for a house is shifting money to/from your house from/to your ‘retirement nest egg’.

Let’s look at an example:

You decide that you need $100,000 a year to live off (before considering mortgage payments) but you want to retire into a nice $750,000 townhouse … your current house, after you pay back its mortgage will provide $250,000 of that, leaving you to ‘find’ $500,000.

Not exactly Ryan’s “multi-million dollar home” but it’ll do for the sake of this exercise …

Scenario 1 – Pay Cash for the House

Let’s see; we need:

a) $500k to pay the cash upgrade to the nice townhouse (on a golf-course, of course!)

b) $2 Million (according to the Rule of 20) to deliver $100,000 (indexed for inflation i.e. so next year it becomes $105k; and so on) living expenses.

So, we can afford to ‘retire’ as soon as we have built a $2.5 Million ‘nest egg’ …simple!

Scenario 2 – Borrow Money for the House

Now we need:

a) $2 Million (according to the Rule of 20) to deliver $100,000 living expenses

b) Another $1,100,000 (according to the Rule of 20) to generate the $4,500 monthly mortgage on the $500,000 townhouse balance (assuming 6.5% fixed interest for 15 years), plus $20k closing costs

Now, we have to wait to retire until we have built a $3,100,000 ‘nest egg’

But, it is actually a wash because we can afford to use the Rule of 10 on the mortgage payments rather than the Rule of 20 … why?

The mortgage is a fixed dollar amount: $4,500 every month for 15 years. If we consistently achieved 10% return on our investments, we would only need $540,000 set aside to generate the required monthly payment.

Then our total nest-egg would be $2,560,000 or a virtual ‘wash’ either way … but, this is heavily interest rate dependent:

– if interest rates are low and investment returns are high: mortgage.

– if interest rates are high and investment returns are low: pay cash.

Since you won’t know which way to expect the interest / investment markets to be aligned when you do retire in 5, 10, or 20 years, my advice is to plan to pay cash …

… calculate your Number using Scenario 1.

That’s what I did … then when I get the urge to invest a little of my home equity, I simply turn up the juice on the HELOC that I have sitting there ‘just in case’ and hop in / out of the investment markets as is my desire.