retirement planning | september 01, 2023
Should I Pay Off My Mortgage Before I Retire?
A mortgage payoff can reduce monthly expenses, lifetime interest costs, and stress, but you should consider your overall financial picture before moving forward with a payoff plan.
Key Insights
Paying off a mortgage can result in both financial and psychological benefits, but factors such as your mortgage rate, retirement savings progress, and liquidity needs should be accounted for as well.
If your goal is to retire mortgage-free, the earlier you can explore and enact an accelerated mortgage payoff plan, the more likely you’ll be to accomplish that goal.
If you’re unable to pay off your mortgage before retiring, there are other options for reducing your expense outlay, such as recasting or relocating.
Lindsay Theodore, CFP®
Thought Leadership Senior Manager
Housing costs tend to make up the greatest share of spending for preretirees and retirees alike. Therefore, it’s no surprise that paying off a mortgage before retirement has become a high priority for many investors. Here are some common trade-offs and sample scenarios individuals often face as they consider how and whether to pay down their mortgage.
1. Allocating Extra Cash Flow to an Accelerated Payoff or Systematic Investment
Should you dedicate additional cash flow to expediting your mortgage payoff or growing your investments?
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Since many preretirees don’t have a large lump sum (beyond their emergency fund) to drop into an investment account or pay off their entire mortgage balance at once, they may consider how additional monthly dollars could be dedicated to either debt paydown or investment accumulation.
If you’re in good shape on the basics—an adequate emergency fund, a savings rate that puts you on track for retirement, and no high-interest credit card balances—you may consider additional mortgage paydown or systematic investment. The debt paydown versus investing trade-off calculation depends on factors such as your risk tolerance, assumed investment return, mortgage interest rate, and personal preferences.
Consider the following scenario. Let’s say a homeowner took out a $300,000, 4% fixed rate, 30-year mortgage 10 years ago. The monthly principal and interest (P&I) payment is $1,432. By the beginning of year 11, due to an increase in their monthly cash flow, they determine that they now have an additional $500 per month they could apply to a systematic investment plan or extra payments toward their mortgage. (Results below are approximate.)
If they opt for the “Accelerated Payoff” route and apply an additional $500 per month toward their mortgage starting at the beginning of year 11:
They will pay off their mortgage in 13 years, cutting seven years of the 20 years of principal and interest payments remaining.
They will save $25,000 in mortgage interest over that 13-year period.
If they opt for the “Systematic Investment” route and pay their mortgage as planned while dedicating $500 per month to a moderate growth investment that generates an annual after-tax return of 6%:
At the end of the same 13-year period, they will have realized $41,000 in investment earnings.
They would accumulate a $119,000 investment balance (principal and gains) but still have a mortgage balance of $103,000.
Because the assumed return of 6% is greater than the 4% mortgage rate, the net worth of the Systematic Investment investor would be $16,000 greater than the net worth of the Accelerated Payoff investor at the end of 13 years.
This example, and its assumptions, illustrates that a systematic investment plan may prove more beneficial from a household balance sheet standpoint. Of course, when choosing between a debt paydown versus an investing approach, you should consider the following:
Your risk tolerance and expected investment returns: The higher your investment return as compared with your mortgage rate, the more beneficial systematic investing would prove to be. If you’re inclined to add to your savings but opt to invest in a more conservative investment such as a money market or bank account, you’ll want to carefully consider whether the earnings potential would exceed the interest rate on your mortgage. Of course, your interest savings by paying off a mortgage are locked in, whereas investment returns are not guaranteed. (See Investing Advantage Based on Annual Return and Mortgage Rate Differential.)
Investing Advantage Based on Annual Return and Mortgage Rate Differential
The greater the difference between the return and the mortgage rate, the greater the advantage for investing.
The assumptions: $300,000 starting loan balance, 30-year term, and $500 applied monthly to either investment or mortgage principal paydown starting at the beginning of year 11. Initial monthly principal and interest payment: $1,264, $1,432, or $1,610 for fixed rate mortgages with rates of 3%, 4%, or 5%, respectively. Assumed annual returns for systematic investment are after taxes, and mortgage interest is not assumed to be tax-deductible. Bars represent the net worth advantage (or disadvantage) for the Systematic Investor, based on the mortgage rate and assumed investment return differential, at the point when the Accelerated Payoff investor would have paid off the mortgage early (around 7 years before the end of the original mortgage term). Keep in mind that investment returns are not guaranteed. While potentially attractive over the long term, returns can be especially volatile and unpredictable over shorter time frames. All investments are subject to market risk, including possible loss of principal. All charts and tables are shown for illustrative purposes only. The scenario above is hypothetical in nature and not meant to represent the return of any actual investment.
Your mortgage interest rate: The lower your mortgage interest rate, the lower the investment return benchmark required to make investing more favorable. The higher your mortgage rate, the lower the likelihood that an investment vehicle’s growth can reasonably outpace it, and the more attractive a debt payoff strategy may be.
Your planned retirement age and debt/liquidity preferences: If paying off the mortgage before retirement is feasible and it would help you to retire more confidently, that path may make more sense. However, if liquidity and growth potential are more attractive, and you’re comfortable with the ups and downs of the market, you may prefer investing.
Your current retirement savings and savings rate: If you’re behind on saving for retirement, it may be prudent to prioritize investing over debt payoff, as growth potential and liquidity will prove necessary to retire comfortably. On the other hand, if your savings rate and balances are on track, it may be reasonable to choose the more conservative approach of allocating additional cash flow to a disciplined mortgage paydown plan.
Your likelihood of sticking to whichever plan you select: Whether you opt to dedicate funds to saving or paying down your mortgage, ensure that it’s a plan you’ll stick to and you won’t be tempted to spend the money instead—which would neither increase your savings nor reduce your debt.
If you would prefer to prioritize an accelerated mortgage payoff at this time, consider your options based on the availability of your cash flow.
Accelerated Payoff Options if Additional Cash Flow Is:
| Steadily Available | Sporadically Available | Somewhat Available |
|---|---|---|
Increase your monthly payments based on the:
|
Whenever you receive periodic cash infusions, through items such as tax refunds, investment payouts, bonuses, or commissions, make lump-sum payments to your principal. | Instead of monthly payments, switch to a biweekly schedule and make half payments every two weeks. Since 26 half payments equate to 13 full payments per year, this may lead to a quicker mortgage payoff and less interest paid. (This may be an especially attractive option if you’re paid biweekly.) |
2. Financing Your Mortgage Payoff With a Lump Sum From Savings
Would paying off the mortgage using a lump sum from your investment assets make sense?
If you’re closer to retirement and you’ve amassed enough savings to consider taking a lump sum to pay off your mortgage (and enter retirement debt-free), it’s important to understand the implications. While paying off the mortgage will add to your home equity and reduce your potential withdrawal need, it will also reduce your liquidity and compounding growth potential over time.
Let’s consider an example. You’re nearing retirement, you have $1,500,000 in pretax retirement assets, you owe $100,000 on your mortgage, and you have seven years of payments remaining. To pay your mortgage and other expenses, you estimate needing $5,000 per month pretax from your investments. We’re assuming the same mortgage terms as section 1.1 (Results below are approximate.)
Based on a 22% income tax rate, to net $100,000 for the mortgage payoff, you would need to sell $129,000 from your investments, leaving you with $1,371,000. Your gross monthly withdrawal need, once the mortgage has been paid off, would be reduced from $5,000 to $3,164.2 To determine whether this would make sense, we must weigh the lump-sum payoff option against the alternative: maintaining current assets and making regular mortgage payments during retirement with the larger monthly withdrawal. (See Ending Investment Balances for Lump-Sum Payoff Versus No Lump-Sum Payoff.)
Ending Investment Balances for Lump-Sum Payoff Versus No Lump-Sum Payoff
Option 1: Pay off the mortgage using a one-time lump sum from investments
Option 2: Continue paying the mortgage using withdrawals from investments
| Option 1: Lump-Sum Payoff |
Option 2: No Lump-Sum Payoff |
|
|---|---|---|
| Starting Investment Balance | $1,371,000 | $1,500,000 |
| Monthly Withdrawal Need | $3,164 | $5,000 |
| Ending Investment Balance after Seven Years (When Mortgage Is Paid Off Under Option 2) |
$1,732,000 | $1,743,000 |
Advantages and Disadvantages of Prioritizing an Early Mortgage Payoff
| Potential Advantages of Paying Off Your Mortgage Before Retirement | Potential Disadvantages of Paying Off Your Mortgage Before Retirement |
|---|---|
|
|
This example and its assumptions show that at the end of the seven years, you’d have $11,000 more in your investment portfolio if you’d chosen option 2. As with the example in the first section, the extent of the advantage, either way, will depend on the investment return compared with the mortgage rate.
If the same individual had opted to take a larger lump sum to pay off the mortgage earlier in the term (for example, 10 years early instead of seven), the results would be similar, but favor option 2 by a greater dollar amount.
This is due to the higher lump-sum withdrawal need, further reduced investment balance, and additional years of lost compounding growth potential.
Key Lump-Sum Withdrawal Payoff Considerations:
Evaluate your risk tolerance carefully here. Investment returns are not guaranteed and can prove irregular, whereas debt reduction and monthly housing expense savings would be guaranteed upon payoff.
If you don’t plan on reducing your withdrawals by the amount of your P&I payment after paying off the mortgage, this comparison may not be applicable. The main reason option 1 could seem attractive to conservative individuals is that their withdrawal need, and potential pressure on their investments, could be meaningfully reduced.
Remember that you will still need to plan for yearly expenses tied to your home, such as insurance, taxes, Homeowner’s Association (HOA) or condo fees, and maintenance after the payoff. Don’t make the mistake of comparing your options under the assumption that taxes and insurance included in your mortgage payment will go away.
3. Achieving Peace of Mind
Will you simply sleep better at night and feel more confident in your financial plan if you eliminate the mortgage?
When deciding whether it would make sense to prioritize paying off your mortgage before you retire, in addition to the financial aspects, you should also consider your personal preferences and goals. If the planning you’ve done will likely lead to a successful retirement, whether you pay off the mortgage or not, you may be inclined to go ahead and expedite paying off the debt.
Alternative Strategies for Managing Housing Debt
If paying off your mortgage before you retire doesn’t seem like a possibility given your circumstances, there are alternative strategies you might consider for firming up your financial position.
1. Refinancing
Although mortgage interest rates are higher today than a few years ago, during periods of lower rates, it may be advantageous to refinance your loan. Refinancing and locking in a lower rate over a similar term will likely reduce your monthly payment, increase cash flow available to invest or spend, and/or reduce the total interest expense you will incur over the life of the loan. By refinancing to a shorter term, from a 30-year to 15-year loan, for instance, you may take on a larger monthly payment but reduce the term and total interest expense. Keep in mind that refinancing often comes with closing costs and other fees and expenses.
2. Recasting Your Loan
One common mortgage provision available to borrowers is the option to recast the loan after a significant lump sum has been applied to the principal. This option allows the borrower to reset the amortization schedule, with the same interest rate and term, based on a lower principal balance. It’s commonly utilized by individuals who realize an unexpected windfall (such as an inheritance or property sale) and wish to reduce their monthly expense outlay. There is typically a one-time fee charged by the lender and a minimum lump sum necessary to become eligible for the recast—anywhere from $10,000 to $50,000—depending on the guidelines outlined in your loan documents. While this action would reduce your monthly payment, it does not shorten the term of the loan. However, if you come into a windfall and cash flow flexibility is important to you, this may be an option to consider.
3. Downsizing and/or Relocating
Another option would be moving to a less expensive area and/or downsizing. It’s quite common for empty nesters who no longer require the space necessary to raise a family to consider moving to a smaller, easier-to-manage, and perhaps more affordable home. This action could reduce your overall housing expense outlay and free up cash flow available to invest, further pay down the new mortgage, or enjoy spending in retirement. Just be sure to consider expenses you may incur with the move, including closing costs on the sale and purchase, moving and new furniture expenses, and, in some cases, capital gains taxes on the sale. Note that a married couple filing jointly is entitled to a $500,000 capital gain exclusion ($250,000 for individuals) on the sale of a home, as long as it served as their primary residence for two of the prior five years.
For some individuals, the satisfaction and peace of mind that comes from eliminating a major debt like a mortgage far outweighs the potential return that could have been realized if that money were invested. It’s important for you to consider the psychological benefits as well as the financial. 
- Lindsay Theodore, CFP®, Thought Leadership Senior Manager
Conclusion
Like many financial decisions, determining whether to pay down a mortgage depends on many personal preferences and financial factors. Weigh the pros and cons and consider seeking the advice of a financial professional.
1Initial mortgage terms: $300,000 starting loan balance; 4% fixed rate; 30-year term; $1,432 P&I payment.
2Calculation for pretax withdrawal need adjustment: $1,432 [net monthly P&I] x (1-.22) [22% tax rate on withdrawals] = $1,836 gross withdrawal adjustment; $5,000 [starting pretax withdrawal need] - $1,836 = $3,164 when mortgage is paid off.
Important Information
This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide recommendations concerning investments, investment strategies, or account types. It is not individualized to the needs of any specific investor and is not intended to suggest that any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only. Past performance cannot guarantee future results.
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