At some point, you’ve probably heard the common wisdom that you should head into retirement without a mortgage to worry about. But the reality is that 40% of individuals who are between the ages of 65 and 74 are still working at paying off their home loans.
Should you be worried if you’re in the sizable minority that still carries a mortgage on your home? Experts say it all depends on your circumstances.
One of the key factors to mull over is the interest rate on your loan. If you’re paying a rate above, say, 5%, the decision to pay down the loan early becomes a little more attractive.
But in today’s low-interest-rate environment, many homeowners are charged less than that. And if you itemize your tax deductions and qualify for the mortgage interest deduction, your effective interest rate is even lower.
Suppose, for instance, that your bank charges 4% annually for your loan and you’re in the 25% tax bracket. If you use the mortgage interest deduction when you file your federal taxes, your actual interest expense is really only 3%. Experts suggest that when the average total return on your investments is more than your mortgage rate, you’re better off keeping your extra dollars in the market.
The other mistake you want to avoid is taking out too big a portion of your investments to prepay the mortgage. Sure, you’ll increase your equity in the home by paying it off early. But if you’re doing it at the expense of more liquid assets like stocks and bonds, you could be putting yourself in a financial bind. Should an unexpected illness or other major expense arise, you want to make sure you have a good way to pay for it.
For homeowners who think they’ll be able to sleep easier without a home loan – and have extra funds lying around – getting rid of your remaining balance starts to make more sense. There are a couple of ways to do it. One is to simply prepay the entire balance in one fell swoop, in which case you’ll want to make sure your lender doesn’t charge a prepayment penalty.
The other, more gradual approach is to pay half your monthly mortgage amount every two weeks. That way, you actually end up making one extra payment each year. In addition to getting rid of your loan faster, you’ll also pay less interest than you normally would.
If you do pull money out of your nest egg to retire a home loan, experts suggest dipping into accounts where you’ll face little or no tax. Investors have to pay the ordinary income tax rate on money they withdraw from a traditional 401(k) or IRA, which makes unnecessary withdrawals a less-than-appealing prospect.Reverse Mortgages: The Other Home Loan