Retiring without a mortgage may sound like a dream, but is it really a smart financial move? With record-low interest rates, could your money be put to better use elsewhere? While lowering your cost of living in retirement is often a smart move, ask these five questions before you rush to pay off your mortgage in retirement.
I just got off the phone with a 60-year-old who was so excited he had just paid off his million-dollar house in Palm Springs. To accomplish this momentous challenge, he stopped contributing to his retirement accounts. Worse, he had run up some credit card debt in the process. Paying off the home will improve his retirement, but he could have likely come out much further ahead if he had put his money to better use over the past few years.
Where Will You Get the Money to Pay Off Your Mortgage?
Suppose you purchased a home years ago and have made the standard payment, which eventually paid off the house. Congratulations! Many people have refinanced over the years and often spread out their payments over a longer period than the typical 30-year mortgage would imply. If you are coming up on retirement and are thinking of making a lump sum payment to get rid of your mortgage, you need to ask, “Where will the money come from to pay off the mortgage?”
If you own $10,000 and have that sitting in a checking account, go ahead and pay off the mortgage. On the other hand, if you owe hundreds of thousands of dollars and will have to raid retirement accounts, think long and hard before you take a taxable withdrawal to pay down your mortgage. If you are still working, the withdrawal will push you into higher tax brackets. In many cases, the higher taxes could more than offset the mortgage savings you think you are getting.
Just in case you were wondering, interest rates were above 9% back in 1991 (30 years ago). Those with good credit could likely find a mortgage below 3% today.
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Could The Money Be Earning More Elsewhere?
The stock market has been soaring for most of the Coronavirus pandemic. Housing prices have also skyrocketed. Heck, even used cars are worth more today than they were two years ago (on average). You don’t need to get fantastic investment returns to beat mortgage rates, especially when considering the after-tax cost of your mortgage. (If you are getting a tax deduction for your mortgage interest, keeping your mortgage costs you less at the end of the day after taxes. It would not be hard to build an investment portfolio that you could reasonably expect to earn more than 3% per year over the long term.
If you are steadfastly against investing (a big mistake in my book) and the money will be just sitting in a checking or savings account, then it would likely make sense to be more aggressive about paying down your mortgage. If you needed to pull money from investments (which would likely incur capital gains taxes), I would think long and hard before making a big lump sum payment towards your mortgage.
Can You Deduct Your Mortgage Interest?
If you are just taking the standard deduction, you are not getting a tax deduction for your mortgage interest. If you itemize when filing your taxes, I will assume you are taking the mortgage deduction. The tax deductions for mortgage interest make keeping the mortgage even cheaper after taxes.
Homeowners in high-tax states with high property values are much more likely to be itemizing their taxes. Think homeowners in Los Angeles, San Francisco, or New York. The higher your income, the more valuable the mortgage deduction can be.
Can You Get a HELOC Now?
Once you retire, getting a new mortgage or even HELOC can be much more difficult. If you have paid off your mortgage before retiring, it could be a smart move to set up a HELOC even if you don’t plan to use it. If you own a home long enough, you will eventually have to do some expensive maintenance. The AC, washing machine, or roof won’t last forever. A HELOC can give you some flexibility to not have to make a large withdrawal from your retirement accounts when the stock market is down, or perhaps, in a year, you already find yourself in a high tax bracket.
Can You Get Another Mortgage If Needed?
Once you are retired, getting another mortgage can be difficult. This is one of the reasons I often advise clients to try and purchase their retirement home before they officially retire. You may have millions in an investment account, but the bank wants to see income. In the case of a retiree with millions, that individual will still likely get a mortgage and will likely still be restrained on how much can be borrowed while at the same time being hit with higher mortgage costs and interest rates.
To be real, most retirees don’t have millions sitting in an investment account; before rushing to pay off your mortgage, make sure you won’t need to access your home equity for quite some time.
In a perfect world, we’d all have our houses paid off by the time we retire, with adequate streams of income to fully maintain our pre-retirement lifestyles. I don’t think I’ve ever met someone who purchased a home and made 30 years of payments to pay off their original mortgage. (This wouldn’t have been a smart move with interest rates dropping over the last 30 years.) All the same, I do know many people who have paid of their mortgage early and more who are on track to do so. Paying off your mortgage may be an excellent financial move, but it likely isn’t going to be the best financial move for your retirement.