Ideally everyone would reach retirement and not have an outstanding mortgage balance, but that is not always the case. Some people choose to keep a mortgage for tax purposes, but often, due to any number of circumstances, retirement approaches and a mortgage balances still exist for many retirees. The outstanding mortgage loan may be on your primary residence or perhaps a second home or vacation property. An analysis of the mortgage as well as other outstanding debt should be part of your financial plan well before making the decision to retire. Let’s look at some items to think about when making the decision to pay off a mortgage.
How long will it take to pay off the mortgage on the current schedule?
First you need to know how long it will take to pay off your mortgage on the current schedule and how that works into your annual spending in retirement. Since mortgages can be taken out for up to 30 years, this can vary widely. There is obviously a big difference between having a few years left to pay versus 25 more years. If you have between one and five years left on the loan, the decision is probably an easier one because short term spending needs tend to be more predictable. It’s harder to discern what future cost obligations, like health insurance or long term care, will be. If your retirement income can support the monthly mortgage payment, it may be wise to keep the mortgage and otherwise allow the assets you would have used to pay it off remain invested.
Where will you get the money to pay off the mortgage?
Where you take the money from to pay off the mortgage could have a major impact on your decision. The biggest factor is the tax status of the money. If you withdraw the money from an IRA, you will most likely be taxed. So taking a significant distribution from an IRA to pay off a mortgage may not make sense. On the other hand, using proceeds from your required minimum distribution may be a good move since that money must be withdrawn. If you use money from a non-retirement account, tax implications still need to be reviewed. If the money is coming from an interest bearing account like a checking or savings account, tax implications are likely to be minimal. If you need to sell stock or mutual fund positions to come up with the cash, capital gains potential should be evaluated. Once you determine your approximate tax liability, you can compare it to the potential interest savings to see if it makes sense.
How much interest will you save?
Your total interest savings will depend on your interest rate, whether it is fixed or variable and how many years you have left on the loan. Paying off your loan early will undoubtedly save you money, but how much depends on the aforementioned factors. Usually you would compare the amount of money saved by paying off the mortgage loan to how much your money could earn by keeping it invested. That’s the tricky part. If the money you will be using is in a bank account or a fixed CD or some other type of liquid savings, then you can make that comparison pretty easily. The difficulty comes when you plan on using money that is invested in the stock market. Because returns are not guaranteed, the task becomes much tougher.
Evaluate all of your options
Paying off your mortgage completely may not be the only option that you have. You could also make one or more lump sum payments over time to reduce the number of years left on the loan. While that strategy normally does not reduce your monthly payment, I have learned of newer mortgage products that do adjust your payment based on additional lump sum payments. Refinancing may also be an option. You may be at a point where you can refinance to a loan with a shorter term or an adjustable rate loan. All costs and current interest rate conditions associated with refinancing should be taken into account before doing so.
Make realistic choices
Once you have done your research on your current mortgage, you can make your decision on paying it off. Like many financial decisions, the right conclusion for you is not always purely mathematical. Some feel more secure having a mortgage but more investment assets while others may have less in the bank but no debt obligations. You need to consider your ability to stick to a plan and make realistic choices. If you think you may be prone to spending the money if it’s in your bank account, then paying off your mortgage may be the right decision for you. Work with your advisor who can help analyze and explore these options and help determine the outcome that is right for you.
Chrissy Canapari, ChFC® serves as Senior Financial Advisor and Manager of Client Services at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at firstname.lastname@example.org.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Chrissy’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.