Most individuals planning their retirements envision their post-work lives as being as free of financial obligations as possible. For those who own their homes, that means being free of mortgage debt.
One of the most common questions financial advisors get is whether it’s best to pay off an outstanding mortgage before settling into one’s golden years or after.
Conventional wisdom says it is best. After all, soon-to-be retirees have every incentive to close out their mortgages before retiring. But conventional wisdom isn’t absolute. And for many retirees, it’s simply not possible given their financial situation.
The best answer to this question depends on what arrangement is best for your wealth — and that answer isn’t always obvious. Today, we’ll look at the question from a couple of important angles.
The benefits of paying off a mortgage before retiring seem to be, on one level, rather obvious:
Most retirees live on fixed incomes that are significantly lower than what they made while working. Income may include distributed funds from retirement accounts and any other investments you may still have. Being free from mortgage debt simply makes day-to-day expenses easier to handle.
Return on investment in retirement isn’t a sure thing – but outstanding mortgage debts are. If the economy falters and the investment market suffers, you’ll lose some of that return. Your mortgage debt, however, stays the same – and you’ll be using a higher percentage of your limited income to pay it off.
Even though mortgage interest payments are tax-deductible, the overall tax benefit won’t move the needle that much in retirement. On top of that, taxpayers need to itemize their deductions to receive mortgage tax breaks. Fewer people are inclined to do so since Congress increased the standard deduction a few years ago.
Furthermore, late-stage mortgage installments usually apply to paying off the principal rather than the interest, so the tax benefits are not as helpful.
Mortgage interest rates are comparatively low at the moment. But if you have a fixed mortgage rate on the higher end – say, more than 3.0% – paying it off before retirement may be especially beneficial.
Most mortgage rates are higher than those of dependable, low-risk investments, such as tax-free municipal bonds. It’s rarely a bad idea to pay off a high-interest mortgage before settling into retirement.
Paying off any kind of debt tends to give a debtor a great emotional boost. Eliminating mortgage debt – the biggest debt many people have in the course of a lifetime – can be especially rewarding from an emotional and psychological perspective.
Many people simply want more peace of mind when they retire. Relieving themselves of the burden of mortgage payments can accomplish just that.
With all of the advantages of a mortgage-free retirement, sometimes the math doesn’t work in a retiree’s favor. But even though freedom from mortgage payments isn’t always attainable, the alternative isn’t necessarily disastrous. And in certain cases, it may be better to extend mortgage payments into retirement.
It may be mathematically sound to continue mortgage payments a few years into retirement. If you’re paying a fixed rate of 3.0% or lower on a 15- or 30-year mortgage, the impact on your retirement income may not be as severe.
Instead of paying your mortgage off sooner with a balloon payment, you can use that money to fund other high-yield investments.
It’s wise to pay off debts with non-deductible, high-interest rates – such as credit cards and personal loans – before settling low-rate debts (which mortgages usually are). Get in the habit of paying down high-interest debts on a regular schedule to make it easier on your budget.
Contributing to your retirement account should come first. If you’ve fallen behind and aren’t making enough contributions to your tax-deferred IRA, hold off on paying your mortgage back in full.
Retirement experts recommend that retirees have enough cash on hand to cover 3 to 6 months of everyday expenses. Life is unpredictable, especially in retirement, and your cash reserves should be sufficient to cover emergencies. If you have a low balance in savings, paying off your mortgage in full may put you at risk.
There’s no hard and fast rule about paying off your mortgage for retirement. As with any financial decision, the answer depends on your finances and current situation. If paying off your mortgage won’t imperil your wealth and overall retirement plan, by all means, consider doing so.
But if paying off your mortgage before retirement jeopardizes your financial health, think about waiting to pay it off in full. After all, your house is just as much an investment as anything else in your portfolio – and a traditionally reliable, “safe” investment at that.
It may be just as wise to keep making lower, regular payments after you’ve retired as part of a sound investment strategy.