Retirees: Paying Off Your Mortgage Could Be Big Mistake

How many times do you read in the personal finance column that the first thing you need to do in retirement is pay off your mortgage?

For many retirees, that could be very bad advice.

This is a great example of how theory often conflicts with reality, and those of us who practice financial planning – advising real people in real life –  have a slightly different perspective than the ivory-tower theorists.

Here’s why you should avoid that knee-jerk reaction to pay off your mortgage and go debt free:

Borrowing is Cheap

If you’ve refinanced fairly recently, the interest rate on your mortgage should be at 4.5% or lower.  Some 30-year fixed mortgages are now near an incredible 3.5% or below.  Once the tax deduction is factored in, you could be paying only 2.5% to 3.4% per year to borrow money.  What’s the likelihood you can earn 2.5% or more after-tax on your investments over the next thirty years?  Pretty darn good.

You Need the Deduction

Hard to believe, but we have many clients whose tax rate is as high or higher in retirement than it was when they were working.  Generally, these are people who receive lots of taxable income in retirement, like pensions and Social Security, and who accumulated large retirement balances in their 401(k)s and IRAs.  Now that they are retired and have to start taking distributions  from their accounts, the taxes are staggering. They can truly benefit from the mortgage interest deduction. Who tends to fall in this category?  Among our clients, it’s government workers, teachers, police officers, and corporate executives.

What Are You Paying Your Mortgage Off With, Anyway?

Many times when retirees say to me they want to pay off their mortgage, I ask, “With what?”  To pay off a mortgage, you need to have a chunk of money sitting there ready, able and willing to be spent.  Taking money out of a retirement plan could be a disaster.  Think of all the taxes and penalties, and why take money out of a tax-deferred environment prematurely?  Even if you have a low earning asset you could use, like a CD or money market account, are you sure you want to lock it up in your house? We all learned in the aftermath of 2008 how hard it is to get money out of your house.  Are you sure you want to put it back in?  If there is a true emergency, and you need cash, where would you rather have your stash … in your house or a more liquid investment?

Borrowing Pays Extra Benefits With Inflation

Think about how your mortgage works.  You borrow money for a long time, say 30 years.  The amount you owe is locked in.  In 30 years, you pay back the amount you’ve borrowed, but because of inflation, the value is only a fraction of what you originally borrowed.  That’s why borrowing over a long period of time in an inflationary environment can be a sound financial strategy.  Over those 30 years, the value of your assets, like your home and investments, grows with compounding and inflation, while the amount of your liability is frozen in time. This isn’t meant to suggest you should borrow recklessly, but it does mean there’s a mathematical advantage to borrowing in times of inflation.

Exceptions to the Rule

As we know, there are always exceptions to the rule.  Here are situations in which it might indeed make sense to pay that mortgage off:

  • You won’t make much on your investments because you insist on investing in cash and CDs.
  • You do not itemize deductions (although it’s still worthwhile to run the numbers).
  • For estate planning or asset protection reasons (at least in Florida), you prefer to keep your equity in your house.
  • You are so extremely risk averse you really don’t care what makes financial (e.g. dollars and cents) sense.
  • Your mortgage interest rate is high (6% or higher) but it’s not worth refinancing because the remaining balance is small, and you’re not getting much tax benefit anyway.
  • You are so undisciplined in your spending that we all agree we need to get as much money out of your hands as possible (sorry but true!).
  • And, of course, you’ve got a big pot of money sitting there to pay off the mortgage (maybe as a result of  large severance payment, required retirement plan distribution, or other lump-sum payment).



About Mari Adam

Mari Adam, Certified Financial Planner™ has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!


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