Should You Pay Off a Mortgage Before You Retire?

If you're like most people, paying off your mortgage and entering your retirement debt-free sounds appealing. It's a significant accomplishment and marks the end of a major monthly expense. However, for some homeowners their financial situation and goals might call for attending to other priorities while chipping away at their home loan.

Let's look at the reasons why you might—or might not—decide to pay off a mortgage before you retire.

• You're trying to reduce your baseline expenses: If your monthly mortgage payment represents a substantial chunk of your expenses, you'll be able to live on a lot less with that payment out of the way. This can be particularly helpful if you have a limited income.
• You want to save on interest payments: Depending on a home loan's size, interest rate, and term, the interest can cost hundreds of thousands of dollars over the long haul. Paying off your mortgage early frees up those funds for other uses.
• Your mortgage rate is higher than the rate of risk-free returns: Think of it this way: Paying off a debt that charges interest can be like earning a risk-free return equivalent to that interest rate. For example, compare your mortgage rate to the after-tax rate of return on a low-risk investment with a similar term—such as a high-quality, tax-free municipal bond issued by your home state. If your mortgage rate is higher than the interest rate offered for those investments—which could be the case for many borrowers as interest rates have remained high—you'd be better off paying down the mortgage than investing the money.
• You want to prioritize peace of mind: Paying off a mortgage can create one fewer worry and increase flexibility in retirement.

Consult with your financial advisor, however, before deciding to pay off your mortgage—either through regular payments or a lump sum. An advisor can help project the impact of this decision on your portfolio. If you decide that a lump sum is the most appropriate way forward, consider tapping taxable accounts before any retirement savings. If you withdraw money from a 401(k) or an individual retirement account (IRA) before you reach 59½, you'll likely pay ordinary income tax—plus a penalty—substantially offsetting any savings on your mortgage interest.

• You need to catch up on retirement savings: If you revisited your retirement plan and discovered that you aren't contributing enough to your 401(k), IRA, or other retirement accounts, increasing those contributions should probably be your top priority. Savings in these accounts grow tax-deferred until you withdraw them.
• Your cash reserves are low: You don't want to end up house rich and cash poor by paying off your home loan at the expense of your reserves. We recommend keeping a cash reserve of three to six months' worth of living expenses in case of emergency.
• You carry higher-interest debt: Before you pay off your mortgage, first pay off any higher-interest loans—especially nondeductible debt from sources like credit cards. It's also good to create a habit of paying off nondeductible debt every month—rather than allowing the balance to build—so that you'll have fewer expenses when you retire.
• You might miss out on investment returns: If your mortgage rate is lower than what you'd earn on a low-risk investment with a similar term, you might consider sticking with your regular monthly mortgage payment and investing what extra you can in potentially higher-yielding investments. This is especially relevant if you secured a low mortgage rate before the current rise in rates. Some investors with more flexibility and more financial resources might feel that there's an opportunity for higher returns for money that could be used to pay off a mortgage in their pre-retirement years. But if you consider investing in riskier or more-volatile investments, remember that those investment returns fluctuate, and higher returns are not guaranteed.

Depending on your current rate and where rates go in the next few years, it may make sense before you retire to refinance into a shorter-term loan (if your goal is to pay off your mortgage more quickly) or into a loan with a lower interest rate (if you want to decrease your monthly payment and free up funds for savings or investment). However, both of those options very much depend on your particular circumstances, and you should carefully consider your options or get professional advice before taking action.

Also, if your mortgage has no prepayment penalty, an alternative to paying your loan off entirely is to chip away at the principal at a faster rate than you would with regularly scheduled payments. You can do this by making an extra principal payment each month or by sending in a partial lump sum when you have the funds. This tactic can save a significant amount of interest and shorten the life of the loan while maintaining diversification and liquidity. But focus on choosing a pace and an amount that works for you or you might compromise your other saving and spending priorities.

In financial planning and wealth management, both sides of your balance sheet matter – your assets (e.g., investments and savings) and your liabilities (e.g., a mortgage or other debt). It may make sense to have a plan where you can both invest and pay down principal on a mortgage before or early into retirement. You don't have to make an all-or-nothing decision.