Suze Orman Money Matters

Bet that got your attention, eh? Let me explain.

I know that many of you are downright terrified by the financial challenge of affording retirement. An innocent-looking online retirement calculator can put you face to face with a "magic number" far scarier for you than anything the Hollywood shock pros could ever dream up for a horror movie. And when we get scared, we get paralyzed and do nothing. Which is just about the worst move (or lack of a move) you could make when it comes to securing your future.

So today we're not going to get bogged down with calculators and scary predictions of how you aren't saving up enough for retirement.

Instead, I want to show you one simple move that can put you on pace to be able to afford retirement. And it has nothing to do with saving. It's all about spending.

Okay, let me slow down and state the obvious here: Yes, of course you need to sock money away in your 401(k)-especially if your employer offers a matching contribution-and yes, you are nuts to pass up a Roth IRA if you are eligible. But one of the best ways to afford retirement is to reduce the amount of money you'll need once you hit retirement. And that's why my favorite retirement "investment" strategy is to speed up your mortgage payments today.

Home In on a Stress-Free Retirement

What I am talking about is spending your 40s and 50s-your prime earning years-paying off the mortgage so that when you stop working you no longer have this big monthly bill to pay. (If you rent, obviously the first goal is to buy a home so you can set up an accelerated mortgage payment plan of your own. You don't want to be paying rent in your golden years any more than you want to be saddled with an unpaid mortgage.) Of course you'll always have property tax, insurance, and maintenance costs to cover, but by eliminating your basic mortgage you will have bought yourself a whole lot of security.

Let's say that right now you are 50 years old and plan to retire in 15 years. You recently refinanced your current home, or bought a new place, and you are carrying a $300,000 30-year fixed-rate mortgage at 6 percent. So your monthly mortgage bill is $1,799. I'm going to assume this is the last home you intend to buy, so you're looking at paying $1,799 a month all the way until you are 80 years old. Yikes. You are indeed going to need some hefty retirement savings to be able to afford that pay-out.

By my calculations, you'll need to have at least $600,000 in your retirement kitty to be able to generate enough income just to make the mortgage payment. To keep this example simple, I am assuming you don't have a company pension, and let's agree to leave Social Security out of the equation for now too, since it is unclear what benefits any of us will receive down the line. So basically we're looking at needing $600,000 in your 401(k) and IRAs for the mortgage alone.

Here's how I got that $600,000 figure: In retirement you need to invest more conservatively than when you are young, so let's say your money will grow at an average rate of 5 percent. A $600,000 pot earning 5 percent will generate $2,500 a month in income. Before you remind me that you only need $1,799 for the mortgage, let me remind you that Uncle Sam takes a huge bite out of all money you withdraw from a 401(k) or a traditional IRA. The withdrawals are taxed as ordinary income; you don't even get to pay any of it at the lower capital gains rates. So let's pick a reasonable tax rate, say 28 percent. That reduces your $2,500 in income to -- drum roll please -- $1,800 after tax.

Yep, you need a huge $600,000 pot just to be able to make the basic mortgage payment. No wonder we get sick to our stomachs when we focus on how much we need to be able to retire. It's also why your best retirement investment today can be to pay off your mortgage. And please don't yelp about losing the tax deduction on the mortgage interest payments. Remember, we're worrying about your retirement. In 15 or 20 years the majority of your mortgage payment is going to be principal, not interest. So just when your income goes down (in retirement) you are not going to be getting much pop from the deduction. Besides, you do realize that, in return for this supposedly great deduction, the reality is that you are forking over tens of thousands of dollars in interest payments? I'd rather reduce my total interest payments by paying off the loan fast.

I also want to issue a huge warning to all of you who are refinancing mortgages today when you are 45 or 50, figuring you will be able to make a killing on the huge equity appreciation the home will have. Watch out. Housing prices simply will not continue to appreciate at the rapid rates we have seen in recent years. Read the housing reports carefully and you will see that prices in once-hot areas are indeed cooling off. I still think real estate is a great investment, but leveraging yourself to the hilt in the largely blind hope it will pay off for you in 10 or 15 years is a big gamble.

Okay, back to my strategy of paying off the mortgage ahead of time.

If you manage just one extra payment a year you will have the loan paid off in 25 years, and you'll save yourself more than $70,000 in interest charges. But that only gets you off the mortgage hook when you're 75. How about we up the ante and you make two extra payments a year? That comes to $3,598 extra a year. Well, that will reduce your payback period from 30 years to 21 years; you'll own the home free and clear when you are 71. Good, but not great.

To really grab the bull by the horns, I want you to consider a 15-year mortgage. That way, you will have the mortgage paid off before, or soon after, you retire. Yes, it's going to require a substantially bigger payment right now, but probably not as much as you think. Don't worry; you don't double the cost of the 30-year to get the monthly cost of a 15-year mortgage. Because you will pay off the loan so much faster, your interest costs are going to be a lot lower, and that keeps the payment from being anywhere near double the cost of a 30-year loan. While you owe $1,799 on the 30-year, if you reduce the payback period to 15 years you will owe $2,532 a month. That's only a $733 increase per month, or a 40 percent hike. Oh and by the way, your total interest costs will shrink from more than $347,000 on the 30-year to less than $156,000. You've saved yourself nearly $200,000!

That said, if you already have a 30-year mortgage, I don't want you to go and spend the time and money to refinance into a 15-year mortgage. I think it's smarter to use a calculator to see how your payments on a 30-year mortgage would change if you change the "term" to 15 years. Then simply send in that extra amount each month, making sure to stipulate that all of your "extra" payment is to go toward paying down the loan principal, not the interest. I like this tack because it gives you maximum flexibility; if an emergency pops up, you aren't locked into making the higher payment.

Again though, if you are buying a new home and are confident you will have the cash necessary to commit to a 15-year mortgage, then by all means take out a 15-year mortgage. A nice bonus for doing so is that the interest rate these days is about half a percentage point lower than the rate on a 30-year loan. So that reduces your total payments even more. At 5.5 percent on a $300,000 mortgage, your monthly payment would be $2,451 and your total interest payments over the life of the loan would be slightly more than $141,000, which is about $15,000 less than if you paid off an existing 30-year loan -- at the higher interest rate -- in 15 years.

I know, I know, some of you are ready to start screaming at me about where in the heck I think you can possibly come up with this extra money to get your mortgage paid off in half the time. Calm down. Because you won't have the burden of a mortgage to worry about in retirement, it makes sense that you will need less income in retirement. Right? So we're going to find you mortgage money today by reducing what you are putting away today for retirement.

Specifically, I want you to scale back on your 401(k) investing. You are to always -- and I mean always -- invest enough so you are assured of getting the maximum annual matching contribution from your boss. But after you reach that threshold, you should consider suspending your payments for the rest of the year and using the extra money that will show up in your paycheck to pay down your mortgage. Just be sure to "re-join" your 401(k) plan in time to start contributions for the next year, so you can once again get the company match. Then just repeat the process year in and year out.

And while it is true that contributing less to the 401(k) now will boost your taxable income, I think that's an okay tradeoff. First, tax rates are near historic lows, so the value of that benefit isn't as great as in the past. Second, and more importantly, remember that making sure you can afford to retire, and that you are at no risk of losing your home, comprise such an essential element of your security and happiness in retirement that they are worth a great deal of possible savings from clever tax maneuvering.

Now, if that doesn't give you enough money to boost your mortgage payments, then you need to look at other money drains in your life. If, for example, you are saving for your children's college education, I want you to divert as much of that money as you need for your mortgage acceleration program. I know that's another unpopular bit of advice. But what's popular isn't always wisest. You need to keep in mind that while there are loans available for your kids' college costs, there are absolutely no loans out there for retirement.

The great added benefit of this strategy is that if you find yourself in a financial squeeze when retirement rolls around, your home could save you. You could use the 100 percent equity in your home to generate income by taking out a reverse equity mortgage. By getting your mortgage paid off, you have not only reduced your income needs in retirement, but you have created a huge emergency cash fund.

Finally, one important caveat: an accelerated mortgage strategy only makes sense if you are in a home you intend to stay in for a long time. If you are in your 20s or 30s and anticipate trading up, then don't rush to pay down the mortgage just yet. Focus on maxing out on all your retirement savings plans. But once you do trade up into your "keeper" home, your goal is to choose a mortgage and payment schedule you can finish before you kick back in retirement.

Now that's not so scary, is it? In fact, the simplicity of it ought to start easing your fears right away. No complicated stratagems are required to really begin meeting the challenge of a secure retirement. Simply spending more now on paying off your mortgage can make it possible to clear retirement's biggest hurdle with room to spare.