Deciding whether or not to pay off your mortgage before retirement requires balancing competing goals. There is no right answer; the best decision might be a combination of what the numbers are telling you and the answer that feels right emotionally to you.
Studies have shown that most people benefit from pre-retirement mortgage payments, but everyone’s situation is unique. Initial factors to consider include the availability of funds and whether paying off your mortgage is the most beneficial use of those funds.
Money in low-interest accounts like bank accounts, CDs, or bond funds is a great source to pay off your mortgage. Avoid withdrawing money from accounts that will incur a high tax bill such as traditional retirement accounts or accounts with large capital gains. You can also benefit by gradually paying off 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 your high-interest debt before making additional payments on your mortgage. Make sure you have an emergency fund and enough cash to cover unforeseen expenses or lost income. If your employer provides a match for your pension plan, increase contributions up to the limit before making additional mortgage payments.
The main benefit of prepaying your mortgage is reduced monthly expenses in retirement. This gives you more flexibility when living off Social Security, pensions, and money withdrawn from retirement savings.
You will also gain the peace of mind that comes with owning your home, knowing that it is safe and will not be foreclosed. Another obvious benefit is saving on the interest you pay on your mortgage.
During the first few years of your mortgage, you may have benefited from a tax deduction for mortgage interest.
However, fewer people nearing retirement get tax breaks on mortgage interest due to the higher standard deduction and the fact that a significant portion of their payment is the principal. In 2018, the IRS reported that 13.9 million people claimed the interest deduction compared to 34 million in 2017.
The potential downside to prepaying your mortgage is that you are using money that could make more money if it were invested in a diversified portfolio. However, the potential benefit of paying off the mortgage is risk free, and the money invested in a diversified portfolio carries market risk. Also, keep in mind that you are investing with borrowed money. Consider whether you would take out a loan on your home to invest in the stock market.
Most retirees take advantage of their mortgage payments and find that the security of the property outweighs the potential for a higher return.
Jane Young is a Certified Paid Financial Planner. She can be reached at [email protected]