Burning Mortgage Question: Should You Retire, Then Pay Off Your Mortgage?

A common question: Should you pay off your mortgage before you retire?

A less common question: Should you retire, then pay off your mortgage?

If you've hemmed and hawed over the benefits of paying off your mortgage versus keeping it, you're not alone. In fact, you might whip back and forth between the two camps of thought — totally normal. 

More and more people are keeping their mortgage into retirement. In 2016, 41% of homeowners ages 65 and older had a mortgage on their primary residence compared with 21% in 1989, according to the Housing Finance Policy Center. The median outstanding debt rose from $16,793 to $72,000. 

The most obvious benefit, of course, is that you can use the money that would otherwise go toward your mortgage toward other things that you want instead. Let's walk through the reasons you might want to keep your mortgage versus getting rid of it altogether. 

What to Consider Before You Decide What to Do with Your Mortgage

You'll want to consider a few things before you decide what to do with your mortgage in retirement. Let's walk through them.

Tip 1: Consider your tax situation.

You're probably fully aware that you can deduct mortgage interest on your taxes. This itemized deduction allows you to count interest you pay on a loan related to building, purchasing or improving a primary home against taxable income, which lowers your tax bite. You can use the deduction for second homes as well. When you no longer have a mortgage, you naturally lose the tax deduction option for mortgage interest payments.

This means you'll either face a decreased tax refund or an increased tax payment, and if you can't stomach either, you may want to consider keeping your mortgage.

However, consider this: You get less of a benefit from your mortgage interest in the later portion of paying off your mortgage because payments go from mostly interest (in the early years of your mortgage) to becoming mostly principal (closer to paying it off).

Tip 2: Consider your available assets.

How much do you have saved up and where is it? In other words, do you have your money stuffed in mostly stocks, or do you have it in a savings account earning little interest?

If you're paying more in interest on your mortgage than what you're earning on your money in your investments (the money you'd use to pay it off), you may want to consider paying off your mortgage. In addition, if you have a lot of retirement savings or you plan to downsize and use the money from your sale to buy your new, smaller home, you may also want to consider paying it off as well. 

Paying off your mortgage may not be in your best interest if you must make withdrawals from a tax-advantaged retirement plan, because it could push you into a higher tax bracket.

Tip 3: Decide whether investing makes more sense.

Investing may make more sense because you might tap into higher returns. For example, let's say you get a 7% return on your investments and your mortgage accrues interest at a rate of 3%. You might argue that investing would be advantageous over paying off your mortgage. However, you've got to earn returns higher than your mortgage for this scenario to work.

Let's say you have a 30-year mortgage of $200,000 with a fixed rate of 5% over a 30-year term. Your monthly payments would be $1,074 (not including taxes and insurance). You'd pay $386,513.11 in total, with interest, if you made no extra payments.

You could take some extra money (say, $200 per month) that you make and put it toward your mortgage, which would mean that you only pay $325,351.71 in interest and principal payments and you'd also pay off your mortgage about eight years sooner.

What if you took your $200 extra per month and invested it in an index fund instead? Let's assume you earn an 8% return on your investment.

At the end of 22 years (about the length of time it would take to pay off your mortgage early), you would have $144,513, which includes the compound interest on your investment. That’s a nice chunk of change. Use mortgage calculators to figure out whether it makes more sense to invest or pay off your mortgage in retirement.

Tip 4: Consider whether you want to pay extra instead.

You might wonder why you have to pay your mortgage off at all. If it makes you sick to your stomach to think about pulling thousands of dollars out of your accounts to pay off your mortgage, remember that there's another way. You can pay a little extra every month or year. If you make bi-monthly payments, you'll automatically make one extra payment per year, which can help nip interest in the bud. You may have traditionally even used your bonus each year and applied it toward your mortgage. Even if you don't have that option anymore, maybe you receive money from an inheritance or you get money some other way. 

If your lender charges for this or you pay a fee for it, you can send in the extra payment on your own. If you receive a large check or unexpected windfall, you can apply those extra funds to your mortgage. If interest rates fall at some point in the future, consider refinancing your mortgage and, if possible, shorten the term of your loan.

Tip 5: Consider refinancing.

If you decide to keep your mortgage, refinancing can decrease the size of your monthly payment and you may want to consider doing so. Lowering the interest rate on your existing loan also saves you money in interest and helps you build equity in your home faster. 

For example, let's say you refinanced your home, which is worth $200,000. You took out a 30-year mortgage loan for $160,000 on the home at a fixed rate of 5%. You pay $859 per month. Let's say you refinanced for 3% instead. You would save on interest over the life of the loan and reduce your monthly payment to $675 instead. (Note that these figures don't include taxes and insurance.)

Is the Payoff Worth It?

Still not sure what to do, after considering your tax situation, your available assets, whether you'd rather invest, pay extra on your loan or refinance? Get a tax expert on your side and a financial advisor to weigh in on your options. 

It's also worth mentioning that there's a psychological payoff to having your home completely paid off — it feels good to be debt free, and that's also a factor you may want to consider as well.