By Joe Delaney
“Shouldn’t I pay off my mortgage before I retire?”
We get this question a lot, and it’s often phrased just like that: “Shouldn’t I?” In other words, “Why in the world wouldn’tI pay off my mortgage if I can?” We’re not really in the business of talking people out of paying off debt, but mortgages are a unique animal. It’s best not to jump to any conclusions before looking at your retirement plan as a whole.
Here are four factors we consider before giving our wholehearted blessing to let that mortgage go:
1. Loan Terms
The first, probably most important factor is your mortgage interest rate. How does it compare to other debt?
It usually makes the most sense to pay off higher interest debt first. Don’t forget that you can get a tax deduction on mortgage interest from your taxes up to $1M (more on that below). That makes the mortgage “good debt”, at least compared with credit card balances and personal loans.
2. Investment Earnings
How are your investments doing?
Compare investment gains with your net borrowing cost on the mortgage. Net borrowing cost = interest you paid last year – reduced tax burden. It’s important to understand the differencebetween a tax creditand a tax deductionwhen you calculate this. Unlike tax credits, which reduce the amount of taxes you pay dollar-for-dollar, a deduction merely reduces the amount of income subject to taxation.
In the 35% tax bracket, for example, $50,000 in interest paid indeed equates to a $50,000 tax deduction,
but the actual amount reduced from the tax burdenis just 35% of that, $17,500. Your net borrowing cost would then be $32,500. This number may very well exceed your investment gains last year because, as you approach retirement, we usually adjust your investments toward a more conservative asset mix (more bonds, fewer stocks) that is more stable with less return potential. If this is the case, it makes sense to review your mortgage options and seriously consider paying it off.
3. Expected Retirement Income
Will you be drawing income from a tax-deferred retirement account?
If your IRA has done well enough that you will be able to enjoy a similar level of income to your working years, it may make sense to retain the tax deductible mortgage debt to offset the taxes you will pay on distributions and future Required Minimum Distributions.
On the other hand, if you will be reducing your income into a lower tax bracket, the benefit of having a mortgage will diminish. Less income, less need for tax breaks. It’s also important to note that the mortgage payment mix changes over time. More goes toward the principal and less toward interest. Less interest paid, less tax burden relief. Under these circumstances it’s not “good debt” anymore. It’s just plain old debt that you might want to pay off if you can.
4. Personal Preference
Sometimes our clients tell us they’ll just sleep better with no debt. That’s a fair argument for paying off the mortgage! You might think of ending mortgage payments as a predictable return on an investment. It’s money you will have freed up to go toward savings and/or re-invest.
The only potential problem with this thinking is the opportunity costof paying off the debt too fast. If making additional payments to the principal means halting the funding of healthy investments, for example, concern for your future may have to outweigh your present peace of mind. It’s important to remember this is not an all-or-nothing decision; the wisest path is sometimes to aggressively pay off a portion of the mortgage and return to regular payments on the remainder.
If you’re still not sure whether you should pay off your mortgage before you retire after reading this article … good! Every situation is different and it’s important we take this question case by case. In other words, we’ve got some math to do.
Come see us at Lifeguard Wealth. You bring your questions. We’ll bring the calculator.
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The opinions expressed by myself and other featured authors are their own and may not accurately reflect those of Lifeguard Wealth. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
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