Many people, including myself, dream of having a “mortgage burning” party the week they retire. The very thought of making my last mortgage payment makes me jump for joy. No mortgage payment means peace of mind, freedom and a strong sense of security. But is it a false sense of security?
Given today’s low interest rate environment, it might make sense to hold onto a mortgage, since the cost of money is relatively inexpensive. With the uncertainty around health care costs, maybe it’s not smart to tie up assets in an illiquid investment. The only way to get money out of a house is to sell it or borrow against it. It may actually be a better option today to keep paying a monthly mortgage payment in retirement rather than using assets to pay it off.
Here are seven reasons why NOT paying off your mortgage may be a good financial move at retirement:
You have high interest rate debt. With 30-year fixed-rate mortgages below 4.5%, it doesn’t make sense to make extra payments on a low interest rate mortgage when you have high interest rate credit cards or student loans.
You aren’t maxing out your retirement savings. One of my clients was paying an extra $170 per month toward her mortgage by simply rounding up her payment to an even $2,000 per month. While this financial move makes sense when taken in a vacuum, it didn’t make sense for her overall financial prospective.
In her case, those dollars could make a bigger difference elsewhere, since she wasn’t capturing her entire company matching contribution. I advised her to decrease her mortgage payment (to the regular payment) and increase her 401(k) to capture the full matching contribution. Her interest rate on her mortgage was only 4.75%, while the company match “earned” her 50% since they matched half of every dollar she invested up to 6% of her earnings.
You are getting a tax break on the mortgage interest. If you are in a high tax bracket AND have a relatively high mortgage, you may want to keep the mortgage rather than paying it off. A taxpayer in a 25% federal tax bracket who has $20,000 in mortgage interest gets a $5000 break on their federal income tax for the interest. If his or her state income tax is 7%, that tax break grows to $6,600.
Don’t be fooled by the promise of a write-off though. People forget that everyone gets one—it’s called the standard deduction. If you are married filing jointly, your standard deduction is $12,400 for 2014 ($6,200 for single taxpayers—other click here). For your mortgage to bring you a tax benefit, you have to have deductions over and above this amount. If the interest on your mortgage is less than the standard deduction, you aren’t getting an additional tax benefit. If your mortgage interest puts you over and above that amount, great! (note – this is not intended to be tax advice. Please consult your tax specialist for guidance specific to your situation. )
Your assets are in retirement plans. If you are planning on withdrawing from your retirement plans to pay off the mortgage, you may get stung by the I.R.S. when tax time rolls around. Unless your funds are in a Roth IRA that you’ve held more than 5 years and you are over 59 ½, you may end up paying income taxes on your lump sum withdrawal from your retirement plan. So withdrawing from your 401(k) or IRA may end up putting you in a higher tax bracket and could negate the tax savings you made on the mortgage interest.
You might need funds to tap into. Fidelity estimates that retirees will need $220,000 for medical expenses in retirement. Retirees may need to tap their assets or increase their income to pay for medical expenses or other unforeseen expenses in retirement. Once funds are used to pay off the mortgage, it’s possible to tap into them but can be quite a challenge. You’d need to borrow against your home using a home equity line of credit, reverse mortgage or sale of the property.
There is a chance you may move. If you may be selling your house, it might be a smart move to hold onto your cash instead of paying off the mortgage. First of all, on the odd chance the real estate market goes south, you have more options (such as a short sale) when you have a mortgage versus owning the property free and clear.
You are earning a decent rate on your funds. As of this writing, the Dow Jones Industrial Average was up over 23% year over year. Investors looking for income can find dividend paying stock or funds that are yielding over 4%. When you can do better than your mortgage rate with your investments, it might not make sense to use those dollars to pay off low interest rate debt.
For many people, paying off their mortgage has less to do with math and more to do with peace of mind. There may be other ways to get that peace of mind without tying up your assets in a house. Consider taking three to five years of mortgage payments and putting them in a separate account. Then directly debit your house payment from it. You’ll have the security of knowing your payment is set for at least a few years.
Another idea is to earmark a particular income stream to make the payment. Social Security income comes to mind first. If you are one of the lucky few who have a pension, set that aside for your mortgage. Since you had funds earmarked to pay off the mortgage, use them to pay it instead. Use the dividends from an investment account or set up a systematic withdrawal for your mortgage payment. Even though you still have a house payment, having a plan to pay it can give you peace of mind you are looking for.
The good news is this is one decision that might not actually hurt you to procrastinate. If you hold onto your lump sum, you can always pay your mortgage off later but once you do, your options are limited.