I’m fast approaching retirement, or as I prefer to say, “work-optional status.” And my mortgage is nowhere near paid off.
This got me thinking – should we follow conventional wisdom and pay off our mortgage now, or keep paying it into retirement?
Retiring Mortgage-Free: The Conventional Mindset
If you’ve paid any attention to personal finance advice, this one should be very familiar: “Don’t enter retirement before you pay off your mortgage!”
And, honestly, it seems to make a lot of sense.
- Paying off your mortgage can sharply reduce your monthly expenses and improve your cash flow.
- Paying off the mortgage removes a large monthly payment, simplifying your budgeting. This is especially important because research shows that you can increase your so-called safe withdrawal rate – the percentage of your portfolio you can draw each year with minimal risk of running out of money before you die – if more of your budget is discretionary. And clearly, removing a multi-thousand-dollar non-discretionary monthly expense will move the needle significantly toward a lower fixed-expense fraction.
- As they say, none of us is promised tomorrow – and if you own your home free and clear, your heirs have more options once they inherit – there’s no debt they must pay off, so they can keep the home and do with it as they prefer. Whether that’s moving into it, renting it out, using it as a vacation home, etc.
- Owning your home outright means you have a lower debt-to-income ratio (even if the income is investment income rather than a monthly paycheck). This makes it easier to borrow when you want or need to. You can also access your equity without selling, through a Home Equity Line of Credit, or HELOC.
- There’s a special peace of mind that comes from knowing your home can’t be taken from you. As many have said, if you have a mortgage, your home is really the bank’s. If you doubt that, consider what would happen if you stopped making your mortgage payments. That’s right – you’d be out on the street in short order.
Michelle Petrowski CFP, CDFA, Founder of Being in Abundance gives great weight to that last point and adds another consideration, “Paying off a mortgage before retirement can create peace of mind. Many retirees sleep better knowing they own their home outright, especially if they’ve weathered job loss, market downturns, or other instability. Having fewer fixed expenses also means less pressure to sell investments in a down market early in retirement, which helps reduce sequence of returns risks.”
Russ Thornton, Founder of Wealthcare for Women agrees, “I always encourage near-retirees to pay down or pay off their mortgage if they can afford to do so without jeopardizing their cash flow or their retirement plan. The psychological benefit is significant based on feedback from many clients, and not having a mortgage will give them additional cash flow flexibility in retirement. If they can’t afford to pay it off before retirement, we’ll often look at taking a big bite out of their mortgage principal via a recast so they can lower their remaining payment amount.”
With all these clear advantages, who wouldn’t want to enter retirement mortgage-free?
Here’s where things stop being so simple…
Why Paying Off Your Mortgage Early Can Gut Your Retirement Finances
If only somebody would swoop in and gift you the hundreds of thousands of dollars needed to pay off your mortgage, but only if you used the money for that purpose…
Nice fantasy.
Reality, however, follows that well-known principle of finances – TANSTAAFL – “There Ain’t No Such Thing As A Free Lunch.”
In our case here, if you pay off your mortgage before retiring, that money must come from somewhere else in your personal finances picture, usually from your portfolio.
Therein lies the rub, paraphrasing Shakespeare’s Hamlet.
The First Trap – Opportunity Cost Reduces Your Income
If you withdraw money to pay off your mortgage, you reduce your monthly expenses, sure. But you also reduce the size of your portfolio. This is especially problematic if, like us, you’re sitting pretty with a 3-percent mortgage interest rate.
Almost any plausible investment should bring in more than a 3-percent return.
Even a high-yield savings account, per Nerdwallet, should bring in between 4 and 5 percent annual interest. And that’s a near-zero-risk asset, federally insured through the Federal Deposit Insurance Corporation (FDIC),
Depending on their maturity, these days, US Treasury bonds can bring in over 4 percent annual return.
In short, by paying off your mortgage early, you’d be leaving safe money on the table, reducing your portfolio income.
The Second Trap – Paying with Expensive Dollars
As long as you stay current on your mortgage, and assuming it’s a 30-year fixed loan like most mortgages, the lender will accept the same number of dollars monthly years down the road as they do now.
The thing is that the dollar keeps losing value each year.
Some years it’s just 2 percent a year, others it can be 10 percent or even more!
If you pay off your mortgage now, you’d be paying off that debt with the most expensive dollars you’ll ever own – today’s dollars, rather than paying with increasingly less valuable dollars each year. And the higher inflation burns, the less your mortgage payments are worth to the bank, and the less they cost you in purchasing power.
The Third Trap – Giving Up a Valuable Tax Deduction
One nice thing about mortgage payments is that (up to $750,000 balance), every dollar you pay in interest brings with it a tax benefit – you get to deduct 100 percent of your mortgage interest each year.
You could argue that in retirement, you’ll be in a lower tax bracket, so you may not even itemize. If so, the mortgage interest tax benefit disappears. However, as the years go by, you’ll be hit with the dreaded Required Minimum Distribution, or RMD. These mandated withdrawals start relatively small, but over the years, they increase dramatically, likely pushing you into ever higher tax brackets.
It’s then that having an interest deduction could matter again.
The Fourth Trap – Lost Liquidity
This one is a bit tricky.
When you pay off your mortgage, you’re pouring potentially hundreds of months’ worth of mortgage payments from a (at least mostly) liquid source in your portfolio into your home equity. That’s money that won’t be there for you if you have an emergency or an investment opportunity that’s too good to miss.
Sure, as mentioned above, a paid-off house can make borrowing easier. However, borrowing money to pay for an emergency is far more expensive than simply using savings.
The Fifth Trap – Giving Up Cheaply Leveraged Appreciation
According to data from Yale economist Robert Schiller, US residential property appreciates somewhere north of 5 percent, on average over the long term.
Imagine you currently owe several hundred thousand dollars on your mortgage, having paid in, say, 20 percent with your initial down payment plus another 10 percent gradually through your monthly payments to date.
If your house value increases by 5 percent, the entire 5 percent gain is yours. However, since you still owe more than twice as much as your equity, your return on investment, so to speak, is nearly 17 percent!
Even accounting for a 3 percent loan interest rate leaves you with an average annual return of more than 13 percent – higher even than the stock market’s long-term average annual return of about 10 percent.
The Sixth Trap – Portfolio Concentration
If you know what you’re doing (or have an investment manager who does), your portfolio is widely diversified such that you aren’t devastated by any single asset crashing.
Liquidate several hundred thousand dollars of that portfolio to pay off your mortgage, however, and you’ve essentially concentrated a large fraction of your net worth in a highly illiquid asset whose value should increase gradually over time but could lose a huge fraction of its value at any given specific time.
Just ask the good people of Nevada about the impact of the 2008 crash on their housing market. Homes there lost over 60 percent of their value!
Now imagine you have a sudden financial crunch, just when the stock market is down and your local housing market is depressed, so selling either financial assets or your home locks in huge losses.
The Seventh Trap – A False Sense of Security Leading You to Overspend
Let’s say you’ve done well and managed to completely pay off your mortgage before retiring.
That’s a huge win, right?
The sense of freedom and emotional peace you experience could make you more subject to financial temptations. After all, you may think you’re not going to lose your home, so why not treat yourself to uber-luxurious annual vacations?
Spend freely enough, and your financial plan can come all undone. Just ask your financial advisor. I’m sure he or she can share more than one story of a retiree feeling flush, overspending until they run out of money with many years of life remaining.
Who Should Pay Off Their Mortgages Before Retiring Despite All That?
No matter what a spreadsheet or personal finance app says, if you can’t stick with a plan because it feels too risky, you won’t.
And then things will start going badly.
So, if one or more of the following apply to you, consider paying off your mortgage as early as you can. Just keep those seven traps in mind and try to avoid them.
- You hate being in any debt, no matter how strategically beneficial it might be, so the peace of mind from owning your home free and clear overrides any monetary benefits you may gain by keeping the mortgage going.
- Having a monthly mortgage payment, even one that’s easily manageable with your investment income, makes you shy away from spending money you can afford to spend so that keeping your mortgage will cheat you out of a better retirement experience.
- Your mortgage balance is relatively small, so you don’t need to cash in too many chips to pay it off.
- Paying off the mortgage will still make a big difference in your monthly cash flow.
- You value financial simplicity above almost all else.
- Your retirement portfolio is somewhat limited, and living on 4 percent of it a year would be difficult. This is because research shows that your safe withdrawal rate increases when your fixed expenses decrease, even if your total spending remains the same, and even more so if it decreases. Thus, you’d have more wiggle room to reduce spending as needed when the market crashes.
- The tax-deferred portion of your nest egg is relatively small, so you don’t expect RMDs to cause your taxes to increase significantly.
- You don’t expect tax rates to increase significantly, expect them to drop, and/or expect the standard deduction to grow to the point that you won’t itemize deductions, making the mortgage interest tax deduction less valuable.
- You expect inflation to be relatively flat (or even negative, i.e., deflation), so you expect the value of current dollars to be not much higher (or even lower) than the value of future dollars.
Kevin Newbert, CFP®, Private Wealth Advisor of Ausperity Private Wealth agrees with the financial benefits of keeping a low-interest mortgage, but recognizes the importance of the emotional aspects, “For clients who locked in historically low mortgage rates in 2020 or 2021, typically in the 2-3 percent range, the math often favors keeping the loan and investing excess capital instead, as the opportunity cost of prepaying can be significant.
“But numbers aren’t the whole story. For some risk-averse individuals, the peace of mind and simplicity that come with eliminating a monthly payment in retirement outweigh the potential gains from trying to outperform their mortgage rate in the markets.”
Like some of his colleagues, Brennan Decima, Owner, Decima Wealth Consulting also emphasizes the emotional benefits of paying off the loan, but adds a nuanced test regarding its feasibility, “A successful retirement is as much about peace of mind and certainty as it is about maximum return. We could all work until the day we die and know that we have zero chance of running out of money, but that doesn’t mean that’s what is best for us.
“For many of our clients, the confidence and joy they get from being mortgage-free outweighs the loss of potential growth of their nest egg from investing their money elsewhere. Sure, you might be able to make more elsewhere, but it’s not a guarantee. Getting out of a lingering outlay is a sure thing.
“As much as having no mortgage in retirement can create peace of mind, that peace of mind should not come at the expense of a successful retirement plan. Many of our clients ask if they should drain their IRA or 401(k) accounts to get rid of their mortgage. We tell them that if doing so would push them into a significantly higher tax bracket, they should avoid paying off the mortgage. This is why we suggest using after-tax dollars, and only if the remaining mortgage balance is less than 1/3 of those dollars. If paying off the loan forces you to give up too much flexibility, it may haunt you down the road.”
Who Should Think Twice (or Three Times) Before Paying Off Their Mortgages?
Personally, I think this group should include most people, and certainly most people whose situation is similar to mine. To make things more specific, let’s flip the previous list on its head. You should seriously reconsider paying off your mortgage early if several of the following are true for you.
- You value financial flexibility and optimization over simplicity.
- You’re comfortable with carrying debt if the interest is low enough to make it financially beneficial.
- If you know your expenses, including the mortgage payment, are easily covered by your investment income, you’d be comfortable spending appropriately to your wealth level.
- Your mortgage balance is relatively high, so paying it off at once would have a significant impact on the size of your nest egg, or, on the flip side, your nest egg is large enough that you can easily cover your expenses, including mortgage payments, while drawing much less than 4 percent annually.
- The mortgage payments are not a significant part of your monthly cash flow.
- You expect tax rates to increase significantly in the future, increasing the value of the mortgage interest tax deduction. You also don’t expect the standard deduction to be high enough in the future to the point that you’d no longer itemize deductions.
- You expect inflation to run relatively hot during the remaining life of your mortgage, so the impact of those fixed monthly payments will decrease significantly.
- The tax-deferred portion of your nest egg is large, so once they arrive, RMDs would increase your income taxes significantly and possibly increase your taxable income enough to push you into Medicare’s Income-Related Monthly Adjustment Amount (IRMAA) territory.
- Also related to the fraction of your nest egg held in tax-deferred accounts, drawing hundreds of thousands of dollars from such accounts at once so you can pay off your mortgage will cause your taxable income in that year to spike, pushing you into the highest tax brackets.
Zack Gutches, Founder & Lead Financial Planner at True Riches Financial Planning agrees with the first point above, but emphasizes the importance of that last one, “While many pre-retirees want to enter retirement debt-free, it’s important to maintain adequate liquidity in your finances heading into retirement. Not having liquidity can reduce lifestyle flexibility in retirement, as well could accelerate withdrawals from tax-deferred retirement accounts, which often come with a 20-plus-percent hurdle via ordinary income taxes. Keeping even a 6-percent-interest mortgage begins to look very attractive when the alternative is accelerating 20-plus-percent taxes on the withdrawals required to retire the debt.”
What I Plan to Do with Our Mortgage
Now that we’ve walked through all the traps, costs, and benefits of the different options, I won’t keep you in suspense any longer.
My personal decision is to keep our 3-percent mortgage for as long as we can, most likely until we move to a smaller house. And if the real estate market is kind to us at that point, we may well be able to sell the house, pay off the mortgage, and have enough left over to buy our next place mortgage-free.
This way, we’d dramatically reduce our monthly expenses without draining any of our financial assets. The best of both worlds.
The Bottom Line
Contrary to conventional wisdom, not everyone should (strive to) pay off their mortgage before retiring.
Your decision needs to balance your nest egg size, its tax-related composition, cash flow, risk tolerance, thoughts on how tax rates and standard deduction size will change over time, inflation expectations, emotional comfort with (strategic, low-interest) debt, and more.
If mortgage payments squeeze your retirement income goals, paying off the mortgage might be right. But if you’re comfortable managing low-cost debt and want your money to work harder, keeping your mortgage will likely grow your nest egg more.
As Ryan Nelson, Founder of Alchemy Wealth Management, says, “Carrying a mortgage into retirement means committing to that fixed payment, which can feel restrictive, especially in years when investment returns are lower or even negative. If your mortgage has an adjustable interest rate, keeping it exposes you to interest rate risk. Another consideration is that changes in tax law could make the loan less advantageous over time.
“If a mortgage payment significantly strains your retirement cash flow, eliminating it can free up resources for living expenses and reduce financial stress. The peace of mind that comes from owning your home outright is hard to quantify, and for some retirees, that emotional benefit outweighs any potential investment gains from keeping the loan.
“However, keeping a mortgage, especially one with a low interest rate, preserves liquidity, which provides more flexibility for unexpected expenses or opportunities. You can also retain more investable assets and greater diversification, potentially earning returns above the loan’s cost (especially after-tax cost), allowing your portfolio to grow. allows you to. Finally, it lets you pay the debt down with future, less valuable dollars, especially if inflation runs high.
“Whether to pay off your mortgage before retirement isn’t purely a math problem. It’s a balance between financial efficiency and emotional comfort. The best plan is the one you can stick to through all market conditions.”
Next, remember that mortgage payments aren’t your only large home-related expense. Other major costs include:
- Property taxes, especially in states like New Jersey, with its notoriously high tax rate.
- Homeowners insurance, which can be especially expensive in jurisdictions with high risk of flooding and/or hurricane damage – in some places it’s become increasingly difficult to find affordable homeowners’ coverage, and you may be forced to get insurance from your state’s insurance of last resort – an expensive solution with sub-optimal coverage.
- Maintenance and repairs, especially if you own an older home and/or one where big-ticket items loom large – think roof replacement, replacing your HVAC system, replacing major appliances, significant landscaping work, etc.
When considering all this, depending on your outlook, you might feel that keeping the mortgage payments is too much to handle or, conversely, that you may as well keep that mortgage.
Your mortgage is a tool, and like any tool, using it correctly makes life easier, while misusing it can cause you serious harm. If you’re comfortable using this tool and are confident you’d use it wisely, keeping your mortgage is likely the savvier way to go.
Finally, keep in mind that the best plan isn’t necessarily the one that offers you the best financial outcome. Rather, it’s the one you can stick with, not just financially, but also emotionally. Otherwise, you’ll never see the plan’s expected benefits but may well be stuck with its drawbacks.
Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the Author
Opher Ganel, Ph.D.
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals. Connect with me on my own site: OpherGanel.com and/or follow my Medium publication: medium.com/financial-strategy/.
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