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Should You Pay off Your Mortgage? A Difficult Decision.

In most cases, it would be optimal to pay off your mortgage before retirement.

However, we do not live in a perfect world.  Not everyone can afford to pay off this massive amount of debt.

According to Fannie Mae, only 1 in 2 homeowners entering their retirement years will pay off their mortgage—within the near future.[1] Of those with mortgage debt, half will not be able to pay off their debt within 8 years.[2] That means planning for retirement becomes even more important. When clients rely on fixed income and cash flow is limited, they will have to make some serious sacrifices to be able to maintain a financially healthy lifestyle.

When considering your options, it’s vital to look at your whole financial picture. Don’t mismanage your mortgage because you didn’t do your homework or misunderstood terms. Ask a lot of questions and get educated.

A client recently told us their mortgage payments were going up. Why? Property taxes skyrocketed as their house increased in value. This is another reason why we recommend not to carry a mortgage in your retirement—especially if you are/or will be living on fixed income.

When You Should Pay Off Your Mortgage Before Retirement:

    • You might be able to lower fixed expenses going forward if you have extra cash and can afford to pay off your mortgage without jeopardizing your future cash flow.
    • You should consider downsizing your home. Paying off your mortgage and moving into smaller space could free up more liquid assets for you to live on (and put less of a physical burden on you to care for and maintain your home). Let your freed-up cash work for you.
    • You might gain more peace of mind. You can sleep a little more restfully at night when you know there’s one less expense item to pay for with retirement income.  Whether it saves you on Social Security or reliance on the markets for investment income, this might be an attractive option for some.

Some people argue that keeping your mortgage can help tax deduction benefits on interest.  For the most part, we disagree.

Consider this example: a man makes $12,000 in mortgage interest payments a year (or $1,000 a month – in addition to whatever principal he still owes). Assuming a 25% tax bracket, he could claim a tax savings of $3,000 and pay a net of $9,000 to the mortgage bank.

That said, why pay the $9,000 at all?  Especially if you already have cash in the bank that earns interest below the rate on your mortgage?  Instead, we suggest paying off the mortgage entirely. The size of our bank account might decrease but think about saving $9,000 every year.

 

When You Should Hold onto Your Mortgage in Retirement

Some people simply do not have the money to pay off their mortgage as they near retirement.

Others might not want to pay off their mortgage right away. For instance, you might have a small mortgage (and/or mortgage payment) at a very low single-digit interest rate. Perhaps you might benefit from drawing out the mortgage for a little while.

Consider a person with a couple of years left until retirement. They are considering paying off a small mortgage (also with a few years remaining on the loan). However, the source of funds is their retirement account. What should they do?

Assuming these are the only relevant factors, we would answer, “No.”

Here are some reasons why:

  • You will pay additional and unnecessary taxes.
    Spending retirement money before retirement can incur an additional tax penalty of 10% in addition to your tax rate if used before age 59 1/2.[3]
  • You give up the opportunity for future growth in your retirement savings. Today, most mortgages carry low single-digit interest rates. For most of the last decade, returns on broad-based investments have been well in excess of that.  There might be major opportunity cost by selling out of a high-return asset to pay off a liability that only costs you modest expense.
  • You might mismanage your balance sheet and endanger your financial health. Most responsible people pay off their mortgages through income generated while they are working.  Their retirement savings is a separate “line item” put away to support them in their golden years.  You should think twice about sacrificing your future retirement to meet a current obligation.

In fact, if you happen to fall into that category and find yourself very tight on money, you might even consider taking out a reverse mortgage. This is where a lender gives you cash for up to 60% of the appraised value of your home.  You must use that cash to pay off your mortgage and any other liabilities on your home first.  Once your home is sold, the reverse mortgage needs to be paid off. While this option is not right for everyone, a few things to keep in mind are: how much cash is needed, the fees associated with getting a reversed loan, your legacy, and the value of your home—among others.

 

As with any loan, you would want to research the interest rate, terms, and eligibility for such a loan.

In the past, it was a rule of thumb for retirees to pay off their mortgage. This is less the case today.

We would encourage you to speak with a fiduciary advisor, who will look at your financial picture holistically. We tend to ask difficult questions in order to challenge you to carefully think through each decision you make. Our goal is to help our clients navigate their lives with purpose and to recommend what’s in the best interest of each individual.

 

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[1] Economic and Strategic Research Group, “Baby Boomers Accelerate Their Advance into Free-and-Clear Homeownership”, Fannie Mae, October 4, 2017, on http://www.fanniemae.com/resources/file/research/datanotes/pdf/housing-insights-100517.pdf  accessed on October 5, 2018.
[2] “Does Your Mortgage Retire With You?”, American Financing on https://www.americanfinancing.net/reverse-mortgage/mortgage-options-after-retirement  accessed on October 5, 2018.
[3] “IRA FAQs – Distributions (Withdrawals)” on https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-distributions-withdrawals  accessed on October 5, 2018.

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