By Jane Young, CFP, EA
The decision to pay off your mortgage before retirement requires balancing competing goals. There is no right answer, the best decision may be a combination of what the numbers tell you, and the answer that feels right emotionally.
Studies have found that most people benefit from paying off their mortgage before retirement, but everyone’s situation is unique. The initial factors to consider include the availability of funds and if paying off your mortgage is the most advantageous use for these funds.
Money in accounts that pay low interest such as a bank accounts, CDs or bond funds are an excellent source to pay down your mortgage. Avoid withdrawing money from accounts that will result in a high tax bill such as traditional retirement accounts or accounts with significant capital gains. You can also benefit by gradually paying down your mortgage before retirement, from your paycheck, rather than making a taxable withdrawal from your retirement savings.
Assuming you have a reasonable source of funding, decide if paying off your mortgage is the best use for your money. Prioritize paying off high interest debt before making extra payments on your mortgage. Ensure you have an emergency fund and adequate liquidity to cover unexpected expenses or a loss of income. If your employer provides a match on your retirement plan, increase contributions up to the match before making extra mortgage payments.
The primary advantage to paying your mortgage off early is the reduction of monthly expenses in retirement. This provides you more flexibility when living on Social Security, pensions and money withdrawn from retirement savings. You will also gain the peace of mind that comes from owning your home – knowing it is safe and will not be foreclosed upon if you are unable to make the payments. Another obvious benefit is saving on the interest you were paying on your mortgage.
In the early years of your mortgage, you may have received a tax deduction for mortgage interest. However, fewer people approaching retirement are getting tax breaks from mortgage interest due to the higher standard deduction and the fact that a significant portion of their payment represents principal. In 2018 the IRS reported that 13.9 million people claimed the interest deduction verses 34 million in 2017.
The potential downside to paying your mortgage early is you are using money that could earn more if it was invested in a diversified portfolio. However, the potential benefit gained by paying off the mortgage is risk free and money invested in a diversified portfolio carries market risk. Additionally, keep in mind that you are investing with borrowed money. Ask yourself if you would take a loan on your home to invest in the stock market.
Most retirees benefit from having their mortgages paid off and they find the security of home ownership outweighs the potential for a higher return.