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Should Retirees Pay off a Mortgage?

yellow house next to caution sign saying "Retirement Ahead"

Consider these pros and cons when thinking about paying off your mortgage before retirement.

Typically, a person would pay off their mortgage after 30 years, and then retire into their golden years. But for many retirees, paying off a mortgage may not be the most beneficial financial move. There are many factors to consider, such as income, mortgage size, savings, retirement, and tax advantages. Let’s weigh out the pros and cons.

Pros of paying off your mortgage:

Deciding to pay off a mortgage can be a smart move for those about to retire who may be in a lower income bracket, have a high interest rate, and don’t benefit from tax-deductible interest.

  • Availability of Funds:

    Your mortgage payment likely represents a large amount of your monthly expenses. Eliminating your payment can leave more funds to meet other expenses.
  • Savings on Interest:

    Depending on your loan amount and terms, a mortgage loan can cost thousands or tens of thousands of dollars in interest. By eliminating having to pay a mortgage bill, you will save money on interest. You may still lose the mortgage interest tax deduction, but paying off your loan can result in significant savings on servicing the debt. The closer you are to paying off your mortgage, more of the payment goes to loan principal which decreases the amount you’re able to deduct.[1]
  • Predictable Return:

    As you probably know, investments can go up – and down. However, if you’re no longer paying interest on your mortgage loan, it’s like earning a risk-free return equivalent to the mortgage interest rate.[1]
  • Peace of Mind:

    If you’re wanting to pay off your mortgage, consider tapping taxable accounts first. If you withdrawal funds from a 401(k) or Individual Retirement Account (IRA) before age 59 ½, you’ll likely have to pay income tax and potential penalties. These payment amounts may significantly offset any savings on your mortgage interest.[1]

Cons of paying off your mortgage:

Consider keeping your mortgage payment if you’re in a higher income bracket, have a low interest rate, and benefit from tax-deductible interest.

  • Insufficient Retirement Savings:

    How much are you contributing to retirement savings? If you’re not contributing enough, this needs to be your number one priority. Check out our Retirement Income Estimator calculator to see what your monthly income will be based on your savings. Since savings in retirement accounts grow tax-deferred until you withdrawal funds, avoid tapping into retirement savings to pay off your mortgage.
  • Insufficient cash reserves:

    Don’t exhaust your cash reserves to pay off your mortgage. Experts recommend keeping a cash reserve of three to six months’ worth of living expenses in the event of an emergency.[1] You don’t want to end up with a paid-off mortgage, and not have any liquid cash for necessities or emergencies.
  • Higher interest debt:

    Before paying off your mortgage, consider if you have any higher-interest debt you could pay off first. Especially expenses with nondeductible debt, like credit cards. If you’re carrying credit cards, here are a few tips on practicing good credit habits.
  • Opportunity Costs:

    If you’re trying to determine whether to invest the funds, or use them to pay off your mortgage, compare your mortgage interest rate to the after-tax rate of return on a low-risk investment with similar terms. Is your mortgage costing you less than you would earn? Run the numbers for the interest rate you’re paying, and compare it to your expected return on investments. If you’re paying 4% interest on your mortgage loan, and are earning 6% on your portfolio, you might consider keeping your mortgage loan.
  • Diversifying your Investments:

    Keeping your mortgage loan open allows you to hold more of other asset classes. Typically, mortgages are a stable investment, however, overconcentration can carry risk.[1]

Strategies to Pay-Off or Reduce your Mortgage

  • Make more frequent payments:

    If your mortgage loan does not have a prepayment penalty, consider paying more toward the principal. Each month, you can make an extra principal payment, or send in a partial lump sum. Making additional payments can help you save money in interest and shorten the life of your loan. However, keep in mind your other saving goals to avoid neglecting spending obligations.[1]
  • Refinance:

    The goal with refinancing is to reduce debt on your primary home over time. Refinancing usually provides a shorter loan term and lower interest rate, which could save you more money in interest. Any mortgage is a liability to your household, and subtracts from your assets. Be sure to evaluate your cost-benefit analysis so you don’t end up increasing your debt.[1]
  • Downsizing:

    How much are you paying for the space in which you occupy? You may not need a large house, or want to keep up its maintenance. Consider if selling your house for a smaller or less expensive home would fit your needs. Depending on the profit from selling your house, you might be able to purchase a new home outright and be debt-free. However, you’ll want to avoid overestimating your current house’s worth, and underestimating the cost of a new home. Keep in mind any tax implications from the sale, and any closing costs.

Deciding whether to pay off your mortgage is a big decision. It can provide a sense of accomplishment, but may not be the best financial move. Be sure to talk with your financial advisor, and they can help look at the whole picture of your finances to see if paying off your mortgage makes sense for your situation.

Sources:

[1] Should You Pay Off Your Mortgage Early, Before You Retire?, Charles Schwab

Should You Pay Off Your Mortgage Before You Retire, U.S. Money News

Should Retirees Pay off Their Mortgage?, Investopedia