The most expensive thing that we see retirees do all the time is buy a vacation home and then call us two or three years later to say they’re selling it. Maybe they thought they wanted a house on the golf course, but they’ve realized they really want to be on the beach. Or they decide they don’t need the heavy maintenance of a full-on second home and want to downsize into an oceanside condo. Most retirees sell second homes within five to seven years for an assortment of reasons. Indeed, The National Association of Realtors found that 28 percent of all people who bought second homes in 2014 planned to sell them in two years or less.
According to the U.S. Census Bureau, Americans live in their primary homes for a median duration of only 5.9 years. How are most of these homes financed? People take on a mortgage with interest rates fixed for 30 years—the most popular mortgage product out there.
Here’s what’s wrong with the picture: they’re paying to insure that their interest rates don’t change for a good 20 years longer than they’re likely to keep the home. Why would anyone pay to lock in a 4 percent rate for 30 years when they’re likely to sell the home and pay off the mortgage in less than 10?
Unless they know that they’re going to hang onto a home forever, a five- or seven-year interest-only adjustable-rate mortgage makes a lot more sense for most people. On a $1 million home, you could pay as much as $10,000 less per year in interest than you would with a 30-year fixed-rate product. The extra money can be invested so that it’s working for the client but available should they need liquidity. Note: it’s not a good strategy for people to take on interest-only payments because it’s the only way they can buy a house they can’t really afford. Those folks won’t have the discipline to self-insure and could end up in financial distress.
Every advisor must understand that when wealthy clients retire and buy second homes they’re likely to move within the first five years for a variety of reasons. They may decide to buy a bigger house, a smaller house, a house in a warmer location, or move into a retirement community. For these folks, especially, interest-only adjustable-rate mortgages make the most sense.