Should You Pay Off Your Mortgage Before Retiring?

Should You Pay Off Your Mortgage Before Retiring?

I get this question a lot from my own clients and from others nearing retirement who own homes on which they still hold a mortgage.  There’s a widely-held belief that you should eliminate all your debt before you retire.  Is that true? And does that include paying off your mortgage?  The answer, as is common to many financial choices, is “it depends.”

My own philosophy in general regarding debt is quite simple.  I believe taking on debt is OK only if (1) you need some asset but cannot afford to purchase it without borrowing money, and (2) you have a plan to pay back the debt in a shorter amount of time than the asset’s lifespan.

A house is a representative example.  You need a place to live, but most of us don’t have enough money to be able to buy a house all in cash.  So instead you utilize a mortgage – a secured, amortized loan – which you commit to paying off in less time than the house is expected to last.  But simply qualifying for the mortgage is not sufficient. You additionally need a plan to save enough each month from your earnings to cover the loan payment (both principal and interest).  Otherwise you would be taking on too much risk with the debt.  The fact that a house is (usually) an appreciating asset helps to further reduce the risk.  If you were unable to keep up the payments for some reason, you would still be able to sell the house to eliminate the debt.

A car loan is similar, but does not provide the same risk-mitigating sales contingency since cars generally depreciate in value over time.  In other words, if you found yourself unable to pay off the loan after several years, selling the car might not bring in enough cash to cover the loan balance.  Therefore it is even more important that you not utilize debt to acquire a car unless you truly need that particular car (rather than a less expensive one) and have a solid plan to pay it back.

What about revolving debt such as credit cards?  I recommend paying them off completely every month unless you are in desperate straits and have nowhere else to turn.  And I do not recommend under any circumstances utilizing debt to pay for investments.  That’s called leverage and is what brought down Lehman Brothers in 2008, triggering a worldwide financial crisis, not to mention the desperate straits that forced you to have to build up that huge balance on your credit cards in the first place.  Enough said.

So back to the original question: what should you do about your debt during retirement (and in particular your mortgage)?  It’s really no problem to keep the mortgage if it meets the two criteria above.  Of course, unless you are living off a pension and/or social security, you most likely have the resources at this point to pay it off.  So why not do so?  Here are a couple of reasons why keeping the mortgage might be the better choice:

  • Your mortgage interest rate is below the return you expect to get from your investments.  If you can get a better return by investing your savings, why use them to pay off the mortgage?  Remember, though, to make the comparison in after-tax dollars, since mortgage interest is tax-deductible.
  • Most of your assets are in retirement plans.  Utilizing funds from your 401(k) or IRA to pay down your mortgage will result in taxes on the amount withdrawn, which could negate any tax benefits you get from deducting the mortgage interest.
  • You need the cash for living expenses or for emergencies.  By paying down the mortgage you would be reducing your liquid assets and increasing the illiquid equity in your home.  If some financial emergency were to occur, it would be much harder to tap that home equity.
  • There’s a chance you might move.  If the local real estate market were to go south, you’d have more options when you have a mortgage (such as a short sale) than if you owned the property free and clear.

Whether or not to keep a mortgage entails more than just financial considerations, however.  Watching your mortgage disappear – or just knowing that you have reached a point in your life where you are able to live completely debt-free – might vastly improve your peace of mind.  Even if it ends up costing you a bit more in taxes or liquidity.  In the end, as long as you follow the two tenets above regarding debt, you are likely to enjoy much more flexibility with your financial options, not only in retirement but throughout your whole life.

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