The common rule of thumb is you should strive to be debt-free by the time you reach retirement. This rule is often sound advice to follow, especially when you consider expensive, inefficient debt such as credit card debt or an auto loan.
Things become more nuanced when you begin to consider a mortgage. Having a mortgage in retirement is not necessarily a bad thing as it is one of the most efficient types of debt you can have. Not only will you get a tax deduction on your payments, you are making payments on an asset that will often appreciate in value.
The decision to carry a mortgage into retirement affects many people who are nearing retirement. About 55% of people ages 55 to 64 currently owe money on their home.* There is no simple answer when it comes to deciding how quickly you should pay off a mortgage. You should consider these factors in order to make the best possible decision.
Your Current Mortgage
If you currently have a variable-rate mortgage, it may be more important for you to pay off the debt quicker than someone with a fixed-rate mortgage. Since we are currently in a low interest rate environment, it is almost certain that interest rates will rise at some point in the future. When that occurs, people with variable-rate mortgages will likely see their rates rise. If you opt to continue to make mortgage payments into retirement, this increase could occur at a time when you are less equipped to deal with an increase in your housing costs.
Your Expected Investment Performance
Rather than paying extra on your mortgage, it may be more beneficial to invest the money instead. For example, let’s say you currently have a mortgage with a 3.5% interest rate, and you think you will earn 5%, on average, on your investments annually. In this situation, it is clear that it would be more beneficial to continue to focus on your investments. While this assessment seems straight-forward, remember that just because you expect to earn 5% on your investments does not mean you will earn 5%. You need to consider the possibility that your investments will earn less than the rate on your mortgage and how you would feel if that happens.
Your Liquid Assets
By focusing on your mortgage and placing less importance on retirement savings, you risk becoming house rich and cash poor. What this means is that while you may have your home paid off, you could be lacking in liquid assets. This is especially important when you are nearing retirement. Will you have the means to generate enough monthly income to maintain your standard of living, or will too much of your money be tied up in your home? If you will not have enough assets to comfortably maintain the standard of living you are accustomed to, it may be better to continue to make mortgage payments in retirement.
Your Current Financial Situation
Are you currently maxing out your contributions to a tax-deferred retirement plan like a 401k? If you are not, it may be better for you to increase your contributions rather than making extra payments on your mortgage. One study found that those who contributed to a tax-deferred plan achieved gains of 11 to 17 cents for every dollar invested that wasn’t used for extra mortgage payments.** If you haven’t reached the contribution limit on your retirement plan, you may be better off increasing the amount you save rather than the amount you pay on your mortgage.
These are just four of the issues that you should consider when it comes to deciding when to pay off your mortgage. Depending on your unique situation, there may be other factors that you should consider. A financial advisor can provide independent guidance that can help you make the decision when you decide to finally pay off that mortgage.
*Annamaria Lusardi and Olivia S. Mitchell. “Debt and Debt Management among Older Adults.” August, 2013.
**Gene Amromin, Jennifer Huang and Clemens Sialm. “The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings.” August, 2006.
Brent has been advising Wealth Enhancement Group clients since 2007. As a believer in the power of teamwork, Brent often leverages the vast knowledge and resources of Wealth Enhancement Group to provide great service and smart strategies to his clients.