Having a mortgage during retirement adds a hefty bill to a post-employment lifestyle. As a result, many people seek to pay off their mortgages entirely prior to retiring. Here are three questions to ask yourself when determining whether paying off your mortgage early is a good strategy for you.
What are the Rates of Return?
One way to evaluate the decision to pay off your mortgage versus keeping more of your money in savings is by comparing the rates of return you expect to earn by following each path. Should you choose to pay off your mortgage, your rate or return is certain; you "earn" the interest rate charged on your mortgage.
If you instead choose to save the money, your rate of return may vary considerably. Your expectation will be determined by how you choose to invest. If you choose to invest very safely, like in a savings account, your rate of return will be quite low, likely below that of your mortgage. If you choose to invest more aggressively, you may very well earn a higher return, but will do so at a cost of significantly more risk and greater uncertainty.
What About the Home Mortgage Interest Deduction?
With every home payment you make, you might benefit from a mortgage interest deduction. However, the benefit of the home mortgage interest deduction may be less than you think, since:
- Your tax rate may be lower than ever - Since you’re in retirement, you’re not working, lowering your income, and lowering your income tax rate.
- Your payment consists of more principal and less interest – Each successive mortgage payment is comprised more of principal and less of interest, reducing the size of your deduction on your tax return.
- Your other itemized deductions are probably lower too – Because you’re in retirement, you’re probably paying less state income tax. Since you only receive a tax benefit to the extent your itemized deduction exceeds your standard deduction, this means you get less of a tax break from your home mortgage payments.
Would You Prefer No Bill or No Cushion?
While it may be of comfort to avoid a mortgage bill every month, you don’t want to pay off your entire mortgage if doing so would leave your without any savings cushion. You’ll never want to pay down your mortgage only to find that you can’t afford to pay for an unexpected car or home repair without going into credit card debt. Ideally, you could pay off your mortgage and have significant savings remaining. Regardless, make sure you retain an emergency fund in retirement.