Does It Make Sense to Pay Off Your Mortgage?

Key Points

  • The decision to pay off your mortgage before you retire involves a balance of practicality and psychology.
  • Doing the math on your mortgage is the first step.
  • Factors such as cash needs and tax deductibility need to be weighed against the peace of mind of being debt-free.

Dear Carrie,

I'm 65 and about to retire and I still have a mortgage balance of $100,000 at 4 percent. My investment portfolio and retirement savings are about $1 million. Should I pay off my mortgage before I retire?

—A Reader

 

Dear Reader,

On the surface, the answer to your question might appear to be a simple calculation. But while your mortgage math is a big part of your decision, there are a few other things to consider including your retirement budget, your taxes and your mindset.

Let's start with the math.

Consider the real cost of your mortgage

You say your current mortgage is at 4 percent. That's reasonably low. But it's even lower once you factor in the tax deductibility. Let’s assume you’re in the 30 percent tax bracket and your mortgage interest is fully deductible. In this instance, a 4 percent mortgage is really only costing you about 2.8 percent.

Factor in future investing opportunity vs. risk

How much your mortgage is costing you is only one side of the equation. On the other side is your investment style and attitude about risk. If you're on the conservative side (and even if you're not, as you move into retirement you may want to invest a little more conservatively), paying off your mortgage would be equivalent to a risk-free 2.8 percent return. With interest rates as low as they are on fixed income investments such as CDs, that's not bad. If you're happy with that return, it could make sense to pay off the mortgage.

But if you think that you can earn more than 2.8 percent from another investment—and you're comfortable taking more risk—then it could make more sense to keep the mortgage and continue to invest that $100,000 elsewhere. So think about your comfort level. Would you prefer to invest your money in potentially higher-yielding investments or take the safer route?

Determine your retirement cash needs

A $1 million portfolio is sizeable, but whether or not it will cover your income needs in retirement depends on your lifestyle. With a $1 million portfolio, you could comfortably withdraw around $40,000 a year. If you reduce your portfolio by $100,000, you'd want to reduce your portfolio withdrawal proportionately as well.

So you need to figure out your retirement budget and whether or not your combination of income sources such as Social Security or a pension as well as your portfolio will meet your needs. On the other hand, if you maintain your monthly mortgage payment, how big of a chunk will that take out of your available monthly cash?

Evaluate your tax situation

Home mortgage debt remains one of the few sources of tax-deductible interest expense left to individuals who aren’t involved in a trade or business. IRS rules say you can deduct the interest expense on up to $1 million ($500,000 for married filing separately) of home-secured debt used to purchase or make capital improvements on your qualified principal and/or second residence.

You can also deduct the interest expense on up to $100,000 ($50,000 for married filing separately) of home equity debt secured by your home, whether in the form of a regular loan or revolving line of credit. Once you’ve paid off the original mortgage, you’ll be limited to the $100,000 home equity debt ceiling unless you make capital improvements or buy another home.

Because your current mortgage balance is $100,000, this may not be important to you. Also, if you have fewer than 10 years left on your mortgage, more of your payment is likely going toward principle than interest, so tax deductibility may not be a real concern.

Think about your peace of mind

For some folks, a strong desire to be debt-free overrides other considerations. There’s an emotional security in owning your home free and clear, and this seems to be especially true for those who are near or in retirement. If that’s the case for you, all other concerns may take a back seat. So you need to weigh the psychological value of having more money in the bank (or in your portfolio) versus being mortgage-free.

As you can see, there isn’t one right answer to your question. It’s more a matter of the right balance for you. If the time you have left on your mortgage is short, if the tax deduction is not significant, and if you’re secure in the amount you've saved for retirement and less concerned about future investing opportunities, you may very well benefit from paying off your mortgage. As always, you should check in with a financial advisor for a more in-depth review of your personal situation.

Ultimately, it sounds like you’re in a good position no matter what choice you make.

Next Steps

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