Hardly a week goes by that I’m not asked the question: “Should I pay off my mortgage before I retire?” The answer, of course, depends. On math. On your situation. On your personal preferences. Let’s look through some of the key variables to consider and then I’ll tell you what I’m doing with my house (spoiler alert: I’m a big proponent of retiring debt free) and give you some tips on how to retire your mortgage early, should you choose to do so.
Variables to consider
Interest rate. What is the interest rate on your mortgage? If you buy a $250,000 home and have a 30-year mortgage at a rate of 4%, you’ll pay $179,674 in interest over the life of that loan. That same loan at 6% would cost $289,595 in interest, about $110,000 more. The higher your interest rate, all else being equal, the more incentive there is to pay it off sooner.
Other debt. Mortgage rates are typically lower than rates on other forms of debt like credit cards or car loans. If you look strictly at the math, it makes sense to pay off your higher interest rate loans first. If you carry a credit card balance or car debt, focus on those first. Once those are gone, you can target your mortgage.
Investment alternatives. Your house is an investment. Whether you use available cash to pay it off will partly depend on the other investment opportunities you have for that available cash. If your mortgage is 4%, but you have another investment opportunity that yields 8%, it might make sense to hold off on the house and invest the cash at the higher rate. Just keep in mind that paying off your house offers a guaranteed return (the interest disappears), while alternative investments likely do not.
Income sources in retirement. Think about your income sources in retirement. Social Security. Pension. Income from your investments. Add that up and then compare it to your retirement budget. Is there enough there to easily service your mortgage without limiting your other plans for retirement? If so, carrying a mortgage in retirement might not be a burden. If not, it might make sense to pay it off early.
Nest egg. Are you on track with your retirement savings? Are you maxing out your 401k and IRA contributions each year? If not, focus on those things first and then, if you still have some extra cash, consider paying down your house second.
Peace of mind. The decision to pay off your house isn’t entirely numbers based. I’ve had plenty of clients who could justify carrying a mortgage, but they paid it off anyway because they wanted the peace of mind of being debt free. I’ve never had a single client tell me that they regret the decision to pay off their house.
How long will you live there? Do you plan on downsizing to a different house or moving somewhere else in retirement? If you only plan on being in your current house for a few more years, it might not make sense to pay it off. If you plan on being there for a while, however, owning it outright would probably be best.
Tax considerations: Many people argue against paying off your house because of the “tax benefit.” Recent changes to the standard deduction make this argument less compelling, but even before then, I think this argument didn’t hold water. Consider a person in the 20% tax bracket who paid $10,000 in interest and got a $2,000 deduction. They paid $10,000 to get $2,000. Better to pay it off, spend a little more on taxes and save the $10,000 in interest.
What I’m doing and why.
As you’ve probably guessed (both from this article and others I’ve written on debt), I’m paying my house off early. I thought through the math, but to be honest, that was secondary. The three primary drivers of my decision are:
- Peace of mind: I sleep better when I’m debt free.
- Security: Debt adds risk and reduces cash flow. Both are bad for retirees.
- Priorities: According to the Employee Benefits Research Institute, the average retiree spends 40-45% of their budget on housing. I have other plans for that money! (For more, read The benefits of an extravagantly modest lifestyle)
A few tips to pay it off early.
Below are a few strategies I use:
- Set a goal and re-run the amortization schedule: If you have 7 years until retirement and want to have the house paid off by then, re-run your loan amortization for 7 years and figure out how much extra you need to pay each month to reach your goal.
- Make it automatic: Once you know how much you need to pay each month, make it automatic. Saving in your 401k is easy because it automatically comes out of your paycheck. Set up your extra principal payments to do the same thing.
- Refinance: Rates are still historically low. If you haven’t refinanced in a while, call your bank to see if it would make sense. Just don’t refinance into another 30-year loan. Keep the payback period as short as possible so more of your payments go to principal.
- Stop escrowing: This is more of a mental trick. When I started paying off my house early, I got discouraged each month at how much of my payments went to taxes, insurance and interest. So I called the bank and asked them to stop escrowing. Yes, I still need to pay my taxes and insurance, but now those bills come separately. Most of my payments go to principal and I’m forced to save extra to cover the taxes and insurance.
- For more ideas, read How (and why) to retire debt free and Your biggest retirement expense (and how to get rid of it).