For many families, a mortgage constitutes a significant portion of their household debt. As a result, some people choose to reduce this debt as much as possible before entering retirement, if not try to eliminate it all together. In fact, nearly one in three retirees have a mortgage loan, and 17% of those paying off debt say that their mortgage is a top financial priority.[i]
But, not all debt is equal. Interest rates have been historically low in recent years, so depending on your rate, your mortgage loan may be the cheapest form of debt you hold.[ii] As such, using your extra money in different ways could make sense. Because everyone’s financial situation is different, many factors can affect choosing whether to pay off your mortgage. It’s important to take into account financial and emotional considerations when making your decision.
As you assess your own mortgage loan, here are 8 common questions to consider:
Have you maxed out contributions to tax-advantaged accounts?
Analyzing the income you will need in retirement is important – yet, only 46% of retirees believe they have enough money.[iii] If you feel comfortable with your retirement savings and the income you be able to generate from your investments, you may be able to devote income to extra mortgage payments. However, the final years before retirement are your last opportunity to boost your contributions and built up your nest egg. If there’s still a savings shortfall, you may want to forgo paying off your mortgage loan early and put those additional funds into tax-advantaged accounts.
Will paying down the mortgage affect your taxes?
If you itemize your taxes, then your mortgage interest payments may be deductible. Once you stop making mortgage loan payments, you can no longer deduct that interest. Further, choosing to pay off your mortgage loan, either before or after you retire, also brings a different set of tax strategies to consider. If you can still benefit from deducting interest on your taxes, then you may want to continue doing so. Keep in mind that it’s important to view your financial situation from a holistic perspective before making any tax decisions.[iv]
Are you still saving for big purchases?
Paying off debt is important, but you need to do it in a smart way. You need to make sure you that your future cash flow needs are addressed so you don’t need to borrow to finance big purchases. Typical big purchases might include:
- Home Remodeling
- Child’s education (529 Plan)
- Wedding
- Car Purchase
- Vacation
There’s no point in paying off the mortgage loan only to go into more debt for a large purchase. Mortgages are the cheapest money you will be able to borrow.
Do you have adequate cash reserves?
Emergency savings are critical for an effective, long-term financial strategy. Unexpected life events, like unemployment, a sudden illness, or home repair, can strain household finances. To adequately prepare, you should aim to have at least 3 to 6 months of cash reserves on hand.[v] By doing so, you’ll be better able to cover major expenses without having to liquidate investments or go into debt. If you do not already have an emergency reserve, this should be a top priority before paying down your mortgage loan.
Do you have other debt?
People in the U.S. are carrying large amounts of debt, which can threaten their financial strategy. In fact, the average person with debt holds at least $38,000 (excluding mortgages), and 45% of retirees carry non-mortgage debt.[vi] If you find yourself in a similar financial situation, you may want to put extra money toward other debt. Further, if any of those liabilities have interest rates higher than your mortgage, then you’ll keep more money in the long run by paying down that debt today. Typical debts include the following:
- Car loans: Most car loans have interest rates higher than mortgages at current rates. Interest on a car loan is also not tax deductible.
- School Loans: Almost always better to pay off a student loan than a mortgage.
- Home Equity Line of Credit: While Second Mortgages may be tax deductible, the interest rates are higher than the mortgage.
- Credit Card Debt: It should go without saying that paying off credit card debt is a high priority. Even if you take advantage of 0% balance transfer offers, these introductory rates only last about 18 months.
Are you investing extra cash in a smart way?
Investing the money you would use to pay off the mortgage may give you a higher return, especially in tax-advantaged or tax-free accounts. If you are invested in a well-diversified portfolio that includes high quality stocks and bonds, you will likely experience a higher return over the long-term than the interest rate you are paying on your mortgage loan.
Are you planning to live in your house for a long time?
A long-term fixed rate mortgage is an inflation hedge, with the risk of inflation assumed entirely by the lender. Even as your cost of living increases, your interest rate stays the same. Over time, the lender receives payments that are less valuable due to inflation.
Will paying off your mortgage bring happiness?
Most financial decisions have emotional components, which is why understanding your long-term goals is important when making a strategy. Psychologically, we dislike the feeling of owing anyone money. For some people, knowing that they own their home, free and clear, outweighs other financial considerations. The security and comfort of being debt-free can be liberating. If being able to pay off your mortgage early aligns with your financial goals, it may be the best decision for you.
The Takeaway
Choosing to pay off a mortgage loan requires a thoughtful analysis of your financial situation. With careful attention to your unique needs, you can make sound decisions that support your long-term goals. If you have any questions or would like to discuss this topic further, we’re happy to help you clarify the opportunities available to you.
[i] https://www.transamericacenter.org/docs/default-source/retirees-survey/tcrs2018_sr_retirees_survey_financially_faring.pdf
[ii] https://www.thebalance.com/fed-funds-rate-history-highs-lows-3306135
[iii] https://www.transamericacenter.org/docs/default-source/retirees-survey/tcrs2018_sr_retirees_survey_financially_faring.pdf
[iv] https://www.thebalance.com/mortgage-interest-deduction-before-and-after-retirement-2388985
[v] https://www.investopedia.com/terms/c/cash-reserves.asp
[vi] https://news.northwesternmutual.com/planning-and-progress-2018
