One of the questions I am asked most often by my clients is whether they should pay off their mortgage before they retire. As with most other questions having to do with planning for retirement, the answer is not always straightforward because it depends on several factors, including your tax situation, how your assets are allocated, cash flow, your liquidity needs, your attitudes toward debt and investment and whether the math makes sense.
That’s a lot to consider in pinpointing the best course of action for you particular situation. As far as debt goes, mortgages have their benefits. But there are situations where paying it off early has advantages. Here’s a look at when it might and might not make sense to pay your mortgage off early. (For more, see: Should You Pay Down Your Mortgage Early?)
When It Might Make Sense
You can’t stand debt. That’s a good enough reason for many people. That was the general attitude in my parent’s generation and it had very little to do with the math. They looked at debt as an obstacle to achieving financial freedom. That’s a strong motivation for many people who simply don’t want to carry any debt into retirement. For many retirees, not having any debt brings them peace of mind.
You want to free up more cash flow for income. A mortgage payment could represent a significant portion of your income. If you’re concerned about being able to meet your monthly expenses, paying off your mortgage might make sense. Being mortgage free means you won’t have to sell any securities at a potential loss or gain to pay expenses and you can avoid taking taxable withdrawals from your retirement accounts.
You want to save on interest costs. Depending on your mortgage balance and the length of the term, you could be paying thousands of dollars in interest costs. By paying off your mortgage, you can free up more money for the future. While you would lose the tax deduction for mortgage interest, you’re paying less in interest costs anyway because an increasing amount of your monthly payment is going towards your principal.
When It Might Not Make Sense
You need to earn higher risk-adjusted returns. If you have sufficient assets and can weather stock market volatility, keeping your mortgage provides the leverage to free up assets to possibly capture higher returns. A well-balanced investment portfolio can potentially generate returns that exceed your mortgage rate.
You can still use the tax deduction. One of the biggest reasons why people don’t want to pay off their mortgage is the loss of the mortgage interest deduction. If you will still have enough itemized deductions to exceed the standard deduction, the mortgage interest deduction could help to increase your after-tax income.
You prefer more liquidity. Paying off your mortgage early requires using excess cash flow or assets that could be invested in liquid investments. While a mortgage-free home holds equity for you, it might require taking out a home equity loan or line of credit should you need to access some cash. That might be more difficult to do as a retiree. Keeping your mortgage intact frees up cash that be invested in liquid assets. (For more from this author, see: 10 Ways to Cut Spending Before Retirement.)
As you can see, there is a lot to consider when deciding whether to pay your mortgage off early. With an increasing number of people approaching retirement with mortgages, retirement income planning needs to take into account the full impact of either decision. As with any major financial decision, it requires thorough planning and analysis to determine how you would benefit the most.