Should Retirees Pay Off Their Mortgage?

Most young folks envision purchasing a home in their thirties with a 30-year mortgage that would be paid off prior to retirement. Unfortunately, it does not always work out that way. The average worker today will change careers seven times in his or her life and buy or rent a few different homes along the way. Homes are often purchased later in life and/or home equity is withdrawn to pay for a variety of financial needs. The result is that many folks still have hefty mortgage balances as they enter retirement. In fact, the number of retirees with mortgages has been increasing. Approximately 35% of homeowners age 65-74 have a mortgage, and the average balance is $118k.

Paying off your mortgage is a big financial decision:

A mortgage is typically the largest loan carried by a household. Whether or not to use savings/investments to pay it off is a big decision. The right answer for your situation depends on your other assets, income, financial goals, and your attitude toward debt.

Below is a list of factors I consider when advising clients whether to pay off their mortgages.

You should PAY OFF your mortgage if…

  1. You have the savings available in money markets, savings accounts, or CDs earning less than the cost of the loan. For example, it is advantageous to pay off (or at least pay down) the loan if the net return on your investments is 1% and the after-tax cost of your loan is 4%. Makes sense, right?
  2. You are risk averse. Paying off your mortgage is like getting a guaranteed return (on the funds used for the payoff) equal to the interest rate on your loan.
  3. You take the standard deduction on your tax return and, therefore, do not benefit from a mortgage interest deduction.
  4. Paying off the loan still leaves you with plenty of liquid assets for emergencies and other spending needs.
  5. You want to free up more of your monthly income for travel and other lifestyle priorities.
  6. Being debt-free would help you sleep at night. Peace of mind is an important consideration that often trumps “the math.”

You should KEEP your mortgage if…

  1. You have a higher risk tolerance and are confident in your ability to earn more on your investments than the interest rate on your mortgage. You should use the after-tax cost of the loan and the after-tax return on your investments. For example, you are better off keeping the loan if the net return on your investments is 7% and the after-tax cost of your loan is only 4%. You would, therefore, be 3% ahead by keeping the loan.
  2. You plan to sell your home soon. There’s little point in paying off a loan that will disappear at the time of sale.
  3. You are still carrying higher cost debt (e.g., you should pay off credit cards before mortgages).
  4. Accessing the funds to pay off the mortgage would trigger a large tax bill. This may be from capital gains, but it’s especially true if the funds are coming from retirement accounts such as an IRA or 401(k).
  5. You are in a high tax bracket and itemize as opposed to taking the standard deduction. You can see how much mortgage interest you are deducting on line 10 of Schedule A of your tax return.
  6. You are not comfortable with the amount of liquid assets you would have left to fund emergencies, general expenses, and discretionary spending after paying off your mortgage.

If you are still working:

I would always advise contributing the maximum to your 401(k), IRA, or other retirement accounts before using current income to pay down your mortgage. However, there is nothing wrong with making extra mortgage payments after you have fully funded your retirement accounts and have 6 months living expenses in a safe, liquid emergency fund.

Hope this helps. Have a great week.