Key Takeaways
- You might prefer to pay off your mortgage before retirement if you’re paying a high interest rate or the mental relief of being debt-free outweighs other financial trade-offs.
- If you have a low interest rate, you might consider keeping the mortgage to free up cash for emergencies or investments.
- The right decision depends on your comfort level, financial cushion, risk tolerance, and the type of retirement you’d like to have.
Retiring with your mortgage paid off can mean less financial stress, but it may not be the best move for you. Whether to pay off your mortgage before retirement can depend on several factors, including the interest rate on your loan, your risk tolerance, and how much flexibility you want in retirement.
On the one hand, paying off your mortgage and having no monthly payment can provide you with a sense of economic freedom. On the other hand, preserving your savings may leave you in a stronger financial position.
How Many Retirees Still Have a Mortgage?
Over the last few decades, studies have shown an increase in the number of older homeowners who carry a mortgage balance into retirement. This shift indicates a shift in financial profiles, with people relying more on home equity and debt in later stages of life.
As a result, older homeowners with mortgages endure more financial strain than their counterparts whose homes have been fully paid off. Studies show that those with mortgages are more likely to contribute more than 30% of their income to housing costs, leaving less money for emergencies, health care, or discretionary spending.
When Paying Off Your Mortgage Makes Sense
Paying off your mortgage before retiring may make sense if it has a high interest rate, particularly if it is higher than what you could earn investing it. In this scenario, paying off your mortgage offers a guaranteed return equal to your interest rate.
If you’re a retiree living on a fixed income, no mortgage payment means your monthly housing costs drop significantly. Without the monthly mortgage payment, your Social Security, retirement funds, or pension will go much further, providing more funds for living expenses, hobbies, and travel.
Also, consider the psychological benefits of owning your home outright, especially if you have a low risk tolerance for investing your money. Living in a debt-free home can provide financial security and peace of mind, enabling you to enjoy your retirement years.
Important
Since inflation can erode your savings over time, earning a return on your investments can potentially offset rising prices and be as effective as reducing debt.
When Saving Your Cash Is Better
Conversely, tying up too much of your savings or net worth in your home can create challenges. Although you might be house rich, the lack of savings can create liquidity issues, meaning you might not have enough cash when you need it.
You might experience an emergency, like medical bills or home repairs. Having cash on hand can help you meet these demands.
If you’re paying a low mortgage interest rate, especially below what some investments might return over time, keeping your money invested may outweigh the benefits of paying off your mortgage.
For example, suppose you have a $100,000 mortgage loan with a 3% fixed interest rate. Instead of paying that loan off, you could invest the $100,000 in a fund that has historically returned an average of 5% per year. After 10 years, if the fund continued to return 5% each year, you’d have about $163,000. After 10 years, you’d have no mortgage and you’d have an additional $63,000. However, keep in mind that investing comes with risk, and you could also lose money.
So What Should You Do: Pay Off Your Mortgage or Keep the Cash Instead?
Before deciding to either pay off your mortgage or hold onto your cash, consider these three questions:
- Does your mortgage rate cost you more than what you can likely earn elsewhere? If it does, then paying it off might be better.
- How much of a financial cushion do you have? Do you have enough accessible cash to cover emergencies? If not, you might safeguard your savings instead of paying off the mortgage.
- How important is peace of mind? For some, living debt-free is a huge relief, while others might prefer the flexibility and growth opportunities that can come with investing.
Going through these questions will help you land on the answer that is right for you and the type of life you want in retirement.
