Many homeowners dream of hosting a âmortgage-burningâ party as they approach retirement. But paying off the mortgage isnât always the best strategy.
Sometimes, itâs better to keep that money in the bank for other purposes, such as building retirement savings or paying down higher-interest debt. In other cases, paying off a mortgage makes sense, especially when you have ample retirement savings and plan to stay in the home for a while. The analysis depends on the terms of your mortgage, the amount of your savings, and your expected retirement income.
âItâs absolutely imperative to run the numbers,â says Catherine Collinson, president of Transamerica Center for Retirement Studies, a division of Transamerica Institute, a nonprofit private foundation funded by Transamerica Life Insurance Co. âEvery case is a little different.â
An increasing number of Americans are facing decisions about what to do with their mortgages as they retire. Baby boomers are swelling the ranks of retirees, and more older homeowners are carrying mortgage debt than in the past. More than 40% of homeowners 65 and older had mortgage debt on their primary residences in 2016, up from 22% in 1995, according to the Joint Center for Housing Studies of Harvard University.
The change has happened for a number of reasons, experts say. Baby boomers as a generation have tended to be less debt-averse than their Depression-scarred parents, says Jennifer Molinsky, Ph.D. , a senior research associate at the Joint Center. And, of course, while interest rates are rising, they are still low by historical standards. âHolding debt in the 1980s when rates were in the teens is a lot different than holding it now,â Ms. Molinsky says.
So how should homeowners approaching retirement evaluate whether to pay off their mortgages? Experts point to several considerations.
If you plan to live in your home for a while or to age in place, then paying off your mortgage can bring peace of mind. âIf youâre able to afford to pay off the mortgage, and youâll have all the retirement assets youâll need, you might just feel better paying off the mortgage, and thatâs OK,â says Jamie Hopkins, director of the Retirement Income Program at the American College of Financial Services. âThere are benefits because it does help with cash flow.â
Thatâs especially true if the interest rate on your mortgage is much higher than the return youâre getting on your investments. For example, if youâre investing in certificates of deposit earning an interest rate of 2%, it makes more sense to use that money to pay off your mortgage if the interest rate is higher, Mr. Hopkins says.
However, if your retirement plans are not fully funded or you lack sufficient savings or emergency funds, keep that cash in the bank and leave the mortgage as is. If youâre not sure you have enough stashed away, consult a financial adviser.
âMost people are better off saving in a tax-deferred vehicle, such as an IRA or 401(k),â Mr. Hopkins says. âThe tax deductions are better that way too.â Here are some things to consider if youâre about to retire and still have a mortgage:
Make a plan
According to the Transamerica Center for Retirement Studies, only 11% of workers over age 65 have a written strategy or financial plan for retirement. âThe fact that so few people have a written financial strategy is quite alarming,â Ms. Collinson says. âOnce you enter retirement, if you find out you donât have the income you expected or have some surprise financial shock, itâs extremely difficult to get back into the workforce.â A written financial plan for retirement is like a reality check to ensure youâre financially ready to retire. Otherwise, you risk outliving your savings.
If youâd like to reduce your mortgage payment, but not pay off the mortgage entirely, you can lower your monthly payments by refinancing and extending the life of the loan. You may be able to lock in a lower interest rate.
Donât touch retirement funds
While itâs not a bad idea to use low-earning savings to pay off a higher-interest mortgage, that only applies if you have more than you need for retirement and emergencies. It does not apply to retirement accounts such as IRAs or 401(k) plans. âMost Americans generate their income in retirement from social security, a 401(k) or IRA,â Mr. Hopkins says. âShould we be taking large withdrawals from them to pay down a mortgage? The answer is no.â Thatâs because you may be subject to a tax penalty of 10% for early withdrawal if you take funds out of an IRA to pay off your mortgage before you turn 59Âœ. And, of course, youâll be depleting your retirement fund.
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