Should You Pay Off Your Mortgage Before Retirement?
December 2, 2020Retirement Wealth
Paying off your home mortgage before you retire is always a sound financial decision and it's the right thing to do.
Many people always balk at the idea of retiring with unpaid home mortgages and rightly so. After all, one of the best ways to successfully prepare for retirement is by getting out of all debts, including your home mortgage. This is because it is an important step towards retirement and one that frees your finances, offers you the peace of mind you require in retirement, and allows you to do other things in the second season of your life.
So should you pay off your mortgage before retirement? Yes, you should pay off your mortgage before retirement. The idea here is that a mortgage is most likely one of your biggest expenses, so making sure that you pay it off before retirement makes a lot of sense. Retiring without a mortgage will give you the financial freedom to spend your pension income on other things such as your favorite hobby or your family. More importantly, you'll have the peace of mind knowing that your home can't be taken away from you.
But even with that, whether or not you should pay off your mortgage before retirement very much depends on your individual financial situation. So in this article, we'll look at both scenarios and let you make the final decision.
Table of contents
Benefits of Paying Off Your Mortgage Before Retirement
There are good and sound reasons why you should pay off your mortgage before retirement. Here are some of them.
Remove Your Largest Monthly Expense
According to the U.S. Bureau of Labor Statistics, mortgages are the largest monthly expenses for most Americans. With that in mind, does it make much sense to you to take such an expense into your retirement? Well, we don't think so. Again, preparing for retirement shouldn't just revolve around saving and investing your money. Instead, you should also have a way of lowering or reducing your basic living expenses. Having lower living expenses means that you'll need less income to lead the type of lifestyle you want and you'll need even fewer assets to help you generate that income.
It's very likely that your mortgage is one of the largest if not the largest expense on your budget. So if you can pay it off before retirement, you will substantially lower your cost of living. In essence, you'll either require less income to lead a comfortable lifestyle in retirement or you'll have extra money to spend on other things other than paying off debt. For example, it's a good way of leaving an extra room within your budget for other things that may increase such as health care.
You also have to remember that your retirement income may partly come from tax-deferred retirement accounts such as Independent Retirement Accounts (IRAs) and 401(k). As such, having a lower monthly expense by paying off your mortgage before retirement could mean that you withdraw less from those accounts and this can help in lowering your tax burden.
Preparing for the Not-So-Generous Tax Deduction
Many people often assume that buying the most expensive house they can afford is a great way of getting some tax deduction or subsidies from the federal government. Well, it is true that real estate taxes and mortgage interests are deductible for income tax purposes. Unfortunately, things can turn bleak when you retire.
You have to keep in mind that a tax deduction only eliminates a percentage of the tax. This means that you may pay more in taxes if you don't have a mortgage but not as much as you'd have to pay in mortgage interests. As such, it may not make sense to carry your mortgage payment into your retirement just to enjoy the not-so-generous tax deduction.
Again, you're most likely to drop to a much lower income tax bracket when you retire. This means that the tax deduction that you're entitled to will be minimal. For example, you may be moved from the 28% marginal tax rate down to the 15% marginal tax rate and that will slash your mortgage tax deduction by half! With that, you will undoubtedly feel the full effect of having to pay your mortgage in retirement, and that's something that you do not want as a retiree.
When it's all said and done, paying off your mortgage before retirement will eliminate what could probably be the largest monthly income that's no longer largely subsidized by the federal government as you had initially thought.
It Frees Up Your Home Equity for Future Sale
Whether you want to downsize to a more appropriate retirement home or need a cash infusion in your retirement, selling your home and transferring the capital to your investment portfolio certainly makes sense. You can only maximize the amount of equity and capital you get from your home sale if you own the house mortgage-free.
In other words, paying off your mortgage before retirement frees up your home equity and makes any future sale a straightforward and easy process. You also get to enjoy the proceeds of your home sale.
You can Easily Rent Out Your Home for an Extra Income
It's always a possibility that you may have to rely on various sources of income in your retirement. Well, you can choose to move to a cheaper home and rent out the home as a way of getting an extra income but this is a lot easier if it's mortgage-free.
This can be a perfect scenario, especially if you want to relocate. For example, it's quite common for retirees to decide to spend most of their time abroad, and renting out your mortgage-free home and getting some income can be much beneficial, especially if you want to change location. Keep in mind that the rental income provides you with a valuable and reliable monthly cash flow, and this is a great way of reducing your overreliance on your other sources of income.
You can Save More Money for Retirement
By paying off your mortgage long before retirement, you free up more money, which you can save for retirement. Once you've paid off your mortgage, you can redirect the monthly payment amount either into a savings account or an investment portfolio.
It's important to have a continuous and ongoing strategy to help you save money regularly. So paying off your mortgage can help you in channeling your attention to saving and investing.
Peace of Mind
There's nothing that's probably more important than having peace of mind in retirement. Believe it or not, debt cannot be a comfortable companion in your retirement as it can be a significant source of stress. This is something that you don't want if you want to enjoy your retirement.
Having a mortgage means that you still owe someone money and there's a possibility of you losing the home if you default on payments. This can happen if things go wrong and you do not have enough income to make the monthly payments. So the best thing to do is to pay off the mortgage before retirement. This would mean that you're out of debt and can give you the peace of mind knowing that you can enjoy your retirement without any fear that your home might be repossessed.
How to Pay Off Your Mortgage Before Retirement
Here's how to pay off your mortgage before retirement.
Known as repayments, mortgages are generally paid in monthly installments. Most lenders allow homeowners to pay up to an extra 10% of the remaining mortgage balance annually. You can make these payments either as a lump sum or monthly and are known as overpayments.
Keep in mind that overpayments can help you pay off the mortgage as quickly as possible. However, you shouldn't exceed the overpayment limits set by your lender as this can result in fines, which may mitigate much of the overpayment benefits.
Mortgages are one of the most competitive products in the financial industry today. This means that the interest rates on mortgages are quite competitive and at an all-time low. That being said, you can choose to switch to a new mortgage deal, which is known as remortgaging. This can save you thousands of dollars but it all depends on your situation.
Remortgaging gives you the chance to increase your monthly payments and shorten the duration of the mortgage but you should only do this if you can afford it. Remember, your monthly payments will be higher than you used to pay. You also have to keep in mind that remortgaging may not be the best move if you are close to retirement, have a small mortgage balance left to repay, or if your credit rating is poor.
When It Doesn't Make Sense to Pay Off Your Mortgage Before Retirement
As we noted earlier, deciding whether or not to pay off your mortgage before retirement very much depends on your individual financial situation. It should depend on whether or not you've saved enough for retirement, how your investment accounts are performing, and your cash flow. Let's look at when it can make sense to continue paying off your mortgage in your retirement.
If You're Earning Higher Rates on Your Investment than You Pay on Your Mortgage
If you've invested in various businesses and your earnings are much higher than the rate of mortgage that you're expected to pay, then it makes much sense to let your mortgage run into your retirement. The idea here is that you can easily afford to pay off the mortgage in your retirement without necessarily relying on your retirement savings.
The best thing to do is to do the math and see if it makes some financial sense. For example, if you earn 7% on your investment portfolio and you're expected to pay 3% on your mortgage, it would make sense to let your investment portfolio grow and pay off the mortgage in your retirement.
If You Have Other Debts with Higher Interest Rates
You should determine whether there are other better ways to spend your money before deciding to pay off your mortgage. You should pay off the debts that have higher interest rates than your mortgage as it will save you more money and leave you in a much better place financially.
If You Haven't Saved Enough for Retirement
Let's be honest here; not all of us retire with enough savings for our retirements. If anything, most Americans do not retire with enough money for their retirement and that's why they continue working well into their late 60s. With that in mind, it would make much sense to continue contributing to your retirement plans and saving accounts rather than pay off your mortgage ahead of schedule.
You Have a Low Cash Reserve
Maintaining an emergency fund is of great importance for your financial stability in your retirement. As such, you shouldn't empty your savings or drain your cash reserve to pay off your mortgage as this can leave you in a very weak position financially. You certainly won't be able to predict when an emergency will occur and this will leave you in a very precarious position. In short, you should have an emergency fund to cater for unexpected life events even if it means paying your mortgage into your retirement.
To this end, it always makes sense to save and invest as much money as you can if you're planning for your retirement. You shouldn't, however, forget to have a comprehensive plan for getting out of debt. Focus on paying off your mortgage and you'll have one of the best retirements but only do it if it makes financial sense depending on your circumstances.
About THE AUTHOR
With multiple family members currently in senior living facilities, David is in the trenches every week, learning the ins and outs of nursing homes, assisted living, memory care, and general senior living.Read more about David Bolton
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