Should You Pay Off Your Mortgage Before You Retire?
Should You Pay Off Your Mortgage Before You Retire? – Carrying a mortgage into retirement goes against the grain of years and years of conventional thought.
The mere thought of carrying a mortgage can become psychologically draining for some. It just feels wrong.
This is what leads to the common question I receive, “should we pay off our existing mortgage before we retire?”
This is a really good question which has no cut and dried answer to it.
My answer always involves asking a lot of questions, so I thought I’d share those with you today in the hope of helping you arrive at a well-informed answer given your unique set of circumstances.
To begin with, I find that folks ask this question for many different reasons.
One of them stems from the traditional belief that you should never have a mortgage in retirement! It was drilled into their minds growing up and it has never left.
That may be a reasonable belief to carry around in the majority of situations. However, it’s certainly not an absolute. Being 100% debt free is not a prerequisite to a successful transition to retirement.
All other variables being equal, it’s terrific if you have no debt. It’s a wonderful accomplishment and an extremely satisfying feeling to owe nothing to anyone!
However, having a mortgage should not prevent you from retiring if your numbers still work.
Key point of emphasis: “if your numbers still work!” (This, of course, implies that you really know your numbers.)
Like every other part of your financial life, carrying a mortgage into retirement should only occur as part of a carefully crafted, well thought out long term financial strategy, and not as a default position.
With all of that said, let’s take a look at some factors you’ll want to consider when evaluating if you should pay off an existing mortgage you have.
Factors to Consider
Factor #1
Do you have enough liquid money to pay off the mortgage? In other words, for simplicity sake, if your mortgage balance is $250,000, do you have $250,000 readily available to use?
You’d be amazed at how many ask this question when they don’t have the $250,000 readily available.
Do you have to pay taxes or penalties to access your money? For example, is all your money tied up in IRAs and 401(k)s?
If so, there’s a tax bill to pay first in order to free up the necessary money. In the example I gave, in order to free up the $250,000 to pay off the mortgage, you would have to withdraw approximately $340,000 from your IRA. After paying roughly $90,000 in federal and state taxes, you would have your $250,000 with which to pay off the mortgage.
This may largely answer the question for you if all your funds are tied up in IRAs. It doesn’t make much sense.
Factor #2
What’s the interest rate on the mortgage, and how long will that rate remain? Is it an Adjustable Rate Mortgage (ARM) where the rate will increase after a certain period of time?
Let’s start with the second part of that question. If you have an ARM, the rate will adjust after a certain period of time. If that’s going to be in a year or two, you have to make some assumptions about what the interest rate will be.
For the purposes of this discussion, let’s assume you know what the rate will be throughout the remaining life of the loan.
What this all comes down to is whether you can potentially “earn” a higher rate of return with the funds you have set aside than the bank is charging you in interest on the loan.
For example, if your outstanding balance again is $250,000 and your mortgage interest rate is 4%, the question is “can you earn more than 4% with the $250,000 you have on the sidelines that you would use to pay off the loan?”
If bank CD rates were much higher than they are today, 8% for example, this would be a no-brainer. You’d keep your $250,000 in the bank CD earning 8% or $20,000 per year, and continue making mortgage payments at 4% ($10,000 per year cost and declining).
To use a fancy term, this is a form of arbitrage and it’s used by many companies in the marketplace every day to finance business operations.
The challenge comes, however, where you can’t earn 8% on a CD and the alternative is investing in a portfolio of stocks and bonds. You may potentially earn more than 4% in a diversified portfolio in the long run. However, there’s no guarantee so you’re taking some form of a risk one way or the other.
It then comes down to how long you have to play the arbitrage game.
Factor #3
The third factor is tax deductibility. Because mortgage interest is potentially deductible, carrying a mortgage may provide another benefit.
The question is whether the mortgage interest is deductible for you. You can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtedness. However, higher limitations ($1 million or $500,000 if married filing separately) apply if you are deducting mortgage interest from indebtedness incurred before December 16, 2017. IRS
Second, it’s only valuable to you if you are itemizing deductions on Schedule A. If you have virtually no deductions on your tax return, and you currently file using a standard deduction because of the current higher limits, the interest deduction from your mortgage is not helping you.
Another smaller factor, but still important, is maintaining some liquidity. If you will have to use up all of your liquid funds to pay off your mortgage, you may want to give some thought to that.
The final Factor stands alone because it’s something I’ve discussed many times with clients over the years.
We can make all of the financial arguments in favor or against keeping an existing mortgage (like in the examples above.) However, at the end of the day, if you have knots in your stomach, or you just can’t stand making mortgage payments, or if being “debt free” has been your lifelong goal and you have the means to pay off your mortgage, just go ahead and pay it off.
I’ve suggested this in several situations. I’m a big believer that you have to be able to sleep at night.
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This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. Please consult your investment professional regarding your unique situation.
Jack Phelps
Managing Partner / Financial Advisor