Retiring mortgage-free sounds like a dream. On the surface, it seems like your biggest monthly expense is eliminated, liberating you to live a more carefree post-retirement life.
That doesn't necessarily mean it's in your best interest to prioritize paying off the mortgage prior to retirement, though. Planning your post-retirement finances is a little more involved and, in some cases, it may make more sense to focus more on liquid retirement funds. The best option for you will depend mostly on your personal circumstances. Either way, this is a decision that will ideally be made well before retirement, since it will ultimately impact how you save your money.
When to consider paying off your mortgage pre-retirement
How long you intend to stay in your current home is the most obvious consideration when deciding if you should pay off your mortgage. If you intend to stay at that location to be near family and friends – and to eventually pass on the property to your children – then it might make the most sense to focus more of your funds on paying off your mortgage. This is especially true if:
- You have enough cash saved to cover the mortgage and still comfortably pay for the costs of living after retirement.
- You will pass the property onto one of your children to make it their permanent place of residence, particularly if you intend to stay there and they have enough income to help support you post retirement.
- You're relatively young and anticipate having ample time left in the workforce to build up savings for retirement.
It's also worth noting that owner-occupied properties may receive a break on capital gains taxes. If you decide later in life that you would like to sell your property, either to downsize, to move in with family, to relocate to an assisted-living community or for some other reason, you can collect on the profits.
Reasons not to pay off your mortgage pre-retirement
The Federal Reserve Board estimates that a third of homeowners between the ages of 65 and 74 have an average balance of $118,000 on their mortgage, according to U.S. News & World Report®. Whether or not that's by design, several reasons exist for why homeowners might choose to keep their mortgage into retirement.
The first consideration is other sources of debt. The average rate for a new credit card is just under 17%, according to USA Today®. This is a little more than triple the average interest rate for a mortgage. Making extra payments toward mortgage debt is not necessarily prudent for anyone carrying high-interest loans.
Current retirement savings also represent a big consideration. Many people heading toward retirement will have money saved in an IRA, 401(k), 403(b) or other retirement-saving vehicle. This is cash that can later be used to pay bills, including your monthly mortgage payments, down the road. Retirees do not necessarily want to find themselves in a situation where they are asset-rich, but cash-poor. Ideally, they'll have access to money when they need it, for monthly budgets, but also for long-term care purposes, emergencies and for leisure.
Furthermore, paying off the mortgage in a lump sum prior to retirement comes with a few cons. First, accessing IRA, 401(k) and other retirement savings before the age of 59 and a half may come with a 10% tax penalty, according to CNBC®. Second, withdrawals from retirements savings are taxed like income. Consequently, a lump sum payment on the mortgage using retirement funds may step you up into a higher tax bracket, ultimately costing thousands of additional dollars in taxes, according to Investopedia®. By comparison, the interest paid on your mortgage is tax deductible as long as the value of the mortgage does not exceed $750,000.
The important thing is to ensure that paying off your mortgage early will not leave all your wealth tied up in your home, and that you're not paying more taxes than necessary.
The verdict: Make a decision suited to your circumstances
There is no right or wrong answer to this question since every retiree will have a slightly different set of risks.
For instance, if the bulk of your post-retirement payments will go toward your mortgage anyway, it might be in your best interest to divert some of the money going into your retirement savings to your mortgage in the decade leading up to retirement. Refinancing your mortgage could be an option in this case if you want to increase your monthly payments.
Whatever route you choose, it's important to have a plan. Estimate your post-retirement monthly budget, figure out how many years of cash reserves you'll need to support your anticipated lifestyle and save accordingly. For more information about mortgages and personal finances, contact the experts at Comerica Bank.
