The question of how to handle mortgage payments in Moneytree Advise comes up often. Handling mortgage payments incorrectly can lead to unintended consequences for a client’s financial plan. Improperly modeling mortgage payments can lead to overstating clients’ total expenses or causing the mortgage to pay off too quickly.
This post will go over the recommended way of modeling mortgage payments. This includes the payments towards principal, interest, property taxes, and insurance. This post will also go over various mistakes made when modeling mortgage payments.
The best way to model mortgage payments is through a blend of personal expenses and debts:
- In the Debts input section: Model principal and interest payments.
- Check the box “Include Current Monthly Payments in Expenses“.
- The program calculates the years on the mortgage based on the current balance, interest rate, and monthly payment entered.
- Once the mortgage is paid, the payments will be removed from the clients’ personal expenses.
- Do NOT include insurance and property taxes or else the years remaining will be understated.
- In the Expenses input section: Include the insurance and property taxes as part of the total.
- Property taxes and insurance payments will continue even after the mortgage is paid.
- Property taxes and insurance payments will increase based on inflation.
- Exclude the principal and interest payments since they are fixed, not subject to inflation.
Additional Mistakes and Notes:
Users are often tempted to enter mortgage payments in Special Expenses:
- The payment will end after a set number of years.
- The payment is fixed, not subject to inflation.
- Expenses entered in the special expense planner prior to retirement force withdrawals directly from assets.
- Income entered in the special income planner prior to retirement is assumed to be saved and reinvested to the client’s assets.
- During retirement Special Income and Expenses can be entered freely since the program accounts for inflow and outflow of cash.
For mortgage payments modeled in Special Expenses, all pre-retirement mortgage payments cause depletion of assets. Since most people pay their mortgage through earned income before they retire, we recommend not modeling existing pre-retirement debt payments in Special Expenses.
Make sure note to include the whole mortgage payments in total expenses:
- Many clients include their mortgage payments their total expenses.
- Payments in Expenses increase based on the expense inflation rate.
- Payments in Expenses do not change except at specific times (ie at retirement, or after one individual passes away).
- If modeled in both Debts and Expenses, then the mortgage payments will be double-counted.
Let’s look at a client who is 50 now and is retiring at 65. The mortgage is scheduled to be paid off when the client is 67, two years after retirement. The monthly payments are $2,000 per month, or $24,000 per year. The balance is $295,000 with an interest rate of 4%, so that the debt will be paid off in 17 years.
Incorrect Method: Using Special Expenss
If entered Special Expense/Goal starting today, the mortgage payment forces withdrawals from the clients’ retirement capital.
Here is the Retirement Capital Analysis with the mortgage payments entered under Special Expense/Goal. You can see the mortgage payments are treated as a shortage prior to retirement, which is pulled from the client’s assets. In this case, the withdrawals are clear. The retirement capital decreases as a direct result of the Special Expense. Some cases are less clear, such as cases where the growth on assets exceeds the expense. With the pre-retirement debt payments depleting the client’s assets, the retirement capital runs out by age 69.
Recommended Method: Using Debts
For the recommended method we will assume that the personal expenses are handled correctly: they include the insurance and property taxes, but not the principal and interest. Instead, we will enter the principal and interest payments in the Debts section like so:
With this model, the program no longer takes money from assets to cover the mortgage payments from ages 50 to 64. Once the client retires at 65, the Spending Needs accounts for the debt payments. The spending needs reduce significantly after 2 years into retirement, at age 67, once the client pays of the mortgage. Though the client still depletes their assets, the age they do so goes from 69 to 85. This leaves much more room to determine a solution to their shortfall.
NOTE: This model for handling mortgage payments can also be used to reflect any other debts, like car payments or credit card debt. Just be sure that whenever that box is checked that the expense is not also being accounted for in the clients’ personal expenses.