Should Your Mortgage Be Paid Off Before RetirementSubmitted by Orange CA Financial Advisor | Sterling Wealth Partners on August 29th, 2016
As you near retirement, there are many things to worry about, for example running out of money, rising health care costs and nursing home care. Another issue to consider is “where do I live during retirement?” According to an AARP study, most people have a strong desire to remain in their current home for as long as possible. While “aging in place” as this is called may be desired, selling and downsizing also has benefits. This decision requires careful thought and analysis to determine which approach is best for you.
If we assume that you will start retirement in your current home, then a decision about paying off your mortgage must be made. Unlike previous generations, where it was expected to have your home paid for by retirement, a Federal Reserve Board study revealed that about half of retirees today have a mortgage. So, the question is “should you pay off your mortgage prior to or at retirement?”
There are a couple of approaches to consider when thinking about this question. One approach is to consider the emotional aspects of having a paid for home, and the other is to look at the decision from a strictly financial aspect. So, let’s look at these two approaches.
The Debt Satisfaction Approach
As just mentioned, it was almost unthinkable for previous generations to not have their home paid for by the time they retired. However, Baby Boomers typically didn’t have this same mind set as they were accumulating their retirement nest egg. Now nearing retirement and having just lived through one of the worst economic downturns in recent history, their risk tolerance has changed. Having that confidence that your home is paid for and you won’t have to worry about losing the home during retirement is resonating with pre-retirees. So from an emotional standpoint, having a home that is paid for is now becoming a priority. The issue, of course, is how to pay off the mortgage.
Ideally, paying down the mortgage during pre-retirement was incorporated as part the financial plan. If not, then what funds are available and what the tax cost would be to use them must be considered. While some may like the peace of mind of having the home paid for, others may not want to use up liquid assets to make a large payment on the mortgage. This may make you feel “house rich and cash poor” so dealing with the emotional aspects of this decision is a very individual thing.
The Financial Approach
As we just discussed, paying down the mortgage can be an emotional issue, but maybe not for everyone. Some will just want to know if paying down the mortgage is the best use of their money. One way to view paying off the mortgage is that the interest cost that is eliminated can be looked at as saving that rate of return on the money used to pay the mortgage. For example, if your mortgage interest is 4%, you are saving 4% on the funds used to pay down the mortgage. However, mortgage interest provides some tax benefits that must be taken into account. So if you have a mortgage interest rate of 4% but you are in a 25% tax bracket, after the loss of the tax benefits you are really saving 3%. One other piece to this equation is what the tax consequences would be on the funds used to pay down the mortgage. For instance, if the money has to come from an IRA then the tax and possible penalty on the IRA distribution makes this less attractive. Using this approach, we can analyze whether it makes financial sense to pay down the mortgage.
Whether to pay down the mortgage prior to or at retirement is a complicated decision. You need to evaluate how important this decision is to you along with the financial and tax aspects of doing this. Let us help you navigate this difficult decision as part of your retirement planning.
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