Should retirees pay off their mortgage?
Paying off the mortgage after 30 years, followed by retirement, was a rite of passage for many. This scenario is no longer the norm: baby boomers, Americans born between 1946 and 1965, have more mortgage debt than previous generations at this stage of life and are less likely than previous generations to own their homes at retirement age, according to a study by Fannie Mae’s Economic and Strategic Research Group.
Whether it makes financial sense for retirees or those approaching retirement to pay off their mortgage depends on factors such as income, mortgage amount, savings, and the tax advantage of being able to deduct mortgage interest.
Key points to remember
- Americans born between 1946 and 1965 have more mortgage debt than any previous generation.
- Paying off a mortgage can be a good idea for retirees or those about to retire who are in a lower income bracket, have a high-interest mortgage, and don’t qualify for tax-deductible interest. .
- It’s generally not a good idea to pay off a mortgage at the expense of funding a retirement account.
When to continue making mortgage payments
Monthly mortgage payments make sense for retirees who can make it comfortably without sacrificing their standard of living. It’s often a good choice for retirees or those about to retire who are in a higher income bracket, have a low-interest mortgage (less than 5%) and benefit from tax deductible interest. This is especially true if paying off a mortgage meant not having a savings cushion for unexpected expenses or emergencies such as medical bills.
Continuing to make monthly mortgage payments makes sense for retirees who can comfortably do so and benefit from the tax deduction.
If you’re retiring in the next few years and have the funds to pay off your mortgage, it may be a good idea to do so, especially if those funds are in a low-interest savings account. Again, this works best for those who have a well-funded retirement account and still have substantial savings for unexpected expenses and emergencies.
Paying off a mortgage before retirement also makes sense if the monthly payments are too high to afford on a reduced fixed income. Entering the retirement years without monthly mortgage payments also means you won’t have to withdraw funds from your retirement account to pay them.
Should retirees pay off their mortgage?
Avoid dipping into retirement funds
Generally, it’s not a good idea to withdraw from a retirement plan such as an Individual Retirement Account (IRA) or 401(k) to pay off a mortgage. If you make a withdrawal before you turn 59.5, you incur both taxes and prepayment penalties.Even if you wait, the tax hit of a large distribution from a retirement plan could potentially push you into a higher tax bracket for the year.
It’s also not a good idea to pay off a mortgage at the expense of funding a retirement account. In fact, those approaching retirement should make maximum contributions to pension plans.
Over the past few years, research has shown that the majority of people are not saving enough for their retirement. In a September 2018 report, the National Institute on Retirement Security found that more than half (57%) of working-age people don’t have a retirement account.The report adds that even among workers who accumulated savings in retirement accounts, the typical worker had a modest account balance of $40,000.
Strategies for paying off or reducing your mortgage
There are a few strategies you can use to pay off a mortgage sooner or at least lower your pre-retirement payments. Making bi-weekly payments instead of monthly payments, for example, means that over a year you’ll make 13 payments instead of 12.
You can also refinance your mortgage if it shortens the loan and lowers your interest rate. While it can be helpful in the long run, refinancing could also hurt your net worth. Remember that a new or old mortgage is a liability for your household, subtracted from a household’s assets.
If you have a bigger house, another option is to downsize by selling your house. If you structure the sale correctly, you may be able to purchase a smaller home with the proceeds from the sale, leaving you mortgage-free. However, the pitfalls include overestimating the value of your current home, underestimating the cost of a new home, ignoring the tax implications of the transaction, and neglecting closing costs.
While paying off a mortgage and owning a home before retirement can provide peace of mind, it’s not the best choice for everyone. If you are retired and/or a few years away from retirement, it is best to consult a financial adviser and have him carefully examine your situation to help you make the right choice.