If you have the means to pay off your mortgage early but choose not to do so, you are in effect choosing to invest with borrowed money. That would make sense if the rate of return on your assets exceeds the interest cost of your mortgage after taking into account risk and taxes. For most people, that is not the case.
Key Takeaways
- If you're thinking about paying off your mortgage before retiring, compare the pros and cons of each option.
- One of the pros of paying off your mortgage is that it is a guaranteed, risk-free return.
- One of the cons of paying off your mortgage is reduced liquidity, as it is much easier to access funds that are sitting in an investment or bank account.
- A study by the Center for Retirement Research concluded that "all except [a] small minority will be better off paying off their mortgage.”
Pros of Paying Off Your Mortgage
One of the pros of paying off your mortgage is that it is a sure way to get a risk-free return. You can invest in safe, risk-free assets like certificates of deposit or Treasurys. However, you'll rarely earn a higher return on those investments than the interest rate you pay on your mortgage.
You might be willing to take risks and approach investing with a long-term view. For that to work, you would need to invest your money in stocks (stock index funds are best to start with) to have the best chance of earning a return that exceeds the cost of your mortgage.
The main risk is mismanagement of investments on your part. For example, many investors earn below-average returns, because they make emotional, not rational, investing decisions.
Keep in mind that debt is a bet on your future ability to pay the money back. While most people are comfortable with taking risks, there's more to think about than the interest rate alone. If life events were to leave you in a place where you couldn't pay your mortgage, where would you go? If you're not able to work to produce income, you have few options. Paying off your mortgage before you retire is the least risky option for most people.
Cons of Paying Off the Mortgage
The biggest downside to paying off a mortgage early is reduced liquidity. It is much easier to access funds that are sitting in an investment account or bank account than to access funds in the form of home equity. Once your home loan is paid off, consider opening a home equity line of credit, so you will have liquidity or access to the equity in your home if you need to.
Study Finds Most Should Pay Off Their Mortgage
The Center for Retirement Research at Boston College conducted a study of retirees, incomes, and mortgages. It concluded that in retired households, paying off a mortgage is better for all but a few people.
The small percentage of people for whom the study found that not paying off a home loan was best were willing to invest an amount in stocks equal to or more than the amount they borrowed for their mortgage. This study looked at both risk and taxes and found that for most retired people, paying off their mortgage is the best option if they have the means to do so.
What Assets Should You Use to Pay Off Your Mortgage?
If you are retired and want to pay off your mortgage early, how do you go about liquidating assets to do so?
First, convert risk-free investments into taxable accounts. Why? You are trading one risk-free asset for another; your savings account for a home with no loan, for example.
Second, convert low-risk investments into taxable accounts for the sake of investments that can earn higher returns. You'd be trading them in for a home you would own free and clear. That would free up income that you could place into other assets or save.
Note
Before using your assets to pay off your mortgage early, you may want to account for the impact that taxes will have on your withdrawals and mortgage.
Third, if you are over age 59 1/2, you could think about withdrawing from tax-deferred accounts. You could use them to pay off a portion of your mortgage.
Note that withdrawals from tax-deferred accounts are included in your taxable income in the year you make the withdrawal. If you take a large chunk of money out of an IRA or 401(k), the extra income could bump you into a higher tax bracket.You can avoid that consequence by breaking up large withdrawals into smaller increments to be withdrawn over several years.
The Balance does not provide tax, investment, or financial services or advice. The information is being presented withoutconsideration of the investment objectives, risk tolerance, or financial circ*mstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.
Frequently Asked Questions (FAQs)
What happens if you pay off your mortgage early?
As long as your loan terms don't include a prepayment penalty, when you make your final payment on the mortgage you're free from your largest monthly expense. Keep in mind that you'll still need to pay for homeowners insurance and property taxes. You probably paid these through escrow before, but now you'll pay them directly to your insurer and local tax agency.
How long of a mortgage should I get?
The ideal mortgage length for you depends on your age, financial obligations, and other financial goals. A shorter term will come with a much higher payment, but you'll pay the loan off sooner. If you go with a longer term, you'll pay much more interest over the life of the loan in exchange for lower monthly payments. You should consider your mortgage terms in connection with your broader financial picture.
When do most people retire?
According to a 2021 Gallup poll, the average retirement age in the U.S. is 62. Those who haven't retired expect to retire later, though—the mean expected retirement age reported on the same poll was 64. In order to get full Social Security benefits, you must wait until age 66, 67, or somewhere in between, depending on when you were born.
FAQs
You might want to pay off your mortgage early if …
You want to save on interest payments: Depending on a home loan's size, interest rate, and term, the interest can cost hundreds of thousands of dollars over the long haul. Paying off your mortgage early frees up that future money for other uses.
What does Suze Orman say about paying off your mortgage early? ›
Orman said she doesn't recommend this strategy if you're 35 and know you're going to move in three or four years. But she does believe that if you are older and your goal is to gain financial security and safety, paying off your mortgage as quickly as possible is a wise idea.
What are the pros and cons of having a mortgage in retirement? ›
Carrying a mortgage into retirement allows individuals to tap into an additional stream of income by reinvesting the equity from a home. The other benefit is that mortgage interest is tax-deductible. On the downside, investment returns can be variable while mortgage payment requirements are fixed.
What are the pros and cons of paying your house off early? ›
Paying off your mortgage early: Pros and cons
- Pro: It frees up cash to invest or pay down debts.
- Con: You lose a tax deduction.
- Pro: You save money on long-term interest.
- Con: You may have to pay a prepayment penalty.
- More pros and cons.
- Other options to explore.
Many Retired People Don't Expect to Pay Off Mortgages
Some retirees living on a fixed income still face a monthly payment on their homes. Traditionally, homeowners looked forward to paying off their mortgage before retirement and living out their golden years without the heavy burden of a monthly house payment.
Is it good to be mortgage free? ›
One of the best parts of paying off your mortgage is you no longer have monthly payments. By eliminating monthly mortgage payments, you free up that cash flow to put toward other things. For example, you could invest the extra money or pay for your child's college tuition.
Should you pay off your mortgage in Suze Orman? ›
Orman recommends that you aim to be mortgage-free by the time you retire. That's because everything you owe, including your home, costs you money, but it can affect your mental health as well. “Debt is bondage,” she says. “You will never, ever, ever have financial freedom if you have debt.”
When retirees should not pay off their mortgages? ›
Paying off your mortgage may not be in your best interest if: You have to withdraw money from tax-advantaged retirement plans such as your 403(b), 401(k) or IRA. This withdrawal would be considered a distribution by the IRS and could push you into a higher tax bracket.
What does Dave Ramsey say about paying off your mortgage? ›
As Ramsey pointed out, paying more than the minimum amount due each month can cut down on the total amount of interest paid. This is because more of your hard-earned money is going toward the principal balance rather than the interest. Paying early and often also can lower the overall loan term.
Is there a disadvantage to paying off a mortgage? ›
A: If you put extra resources toward a home loan, you'll no longer have access to that cash flow and that's one of the disadvantages of paying off a mortgage. That means it's important to establish an emergency fund first — generally three to six months of living expenses — for unexpected financial needs.
Yes, it is possible to retire comfortably on $500k. This amount allows for an annual withdrawal of $20,000 from the age of 60 to 85, covering 25 years. If $20,000 a year, or $1,667 a month, meets your lifestyle needs, then $500k is enough for your retirement.
At what age should your house be paid off? ›
If you are under 45, it's difficult to argue that your dollars would be better served paying off your mortgage unless you are on Step 9, pre-pay low-interest debt. You should aim to be completely debt-free by retirement, and after age 45 you can begin thinking more seriously about pre-paying your mortgage.
Is it smart to completely pay off your house? ›
Key takeaways. Paying off your mortgage early can provide several benefits, including peace of mind and freed-up cash flow. However, paying off a mortgage early is not always the best idea, even if you have the money.
How does paying off your mortgage affect your taxes? ›
Should I pay off my mortgage early? There are both pros and cons to paying your mortgage off early. While you save on interest and have extra funds to use elsewhere, you will lose the federal mortgage interest tax deduction and could miss out on more lucrative investments.
How to pay off a 250k mortgage in 5 years? ›
Increasing your monthly payments, making bi-weekly payments, and making extra principal payments can help accelerate mortgage payoff. Cutting expenses, increasing income, and using windfalls to make lump sum payments can help pay off the mortgage faster.
At what age should a house be paid off? ›
If you are under 45, it's difficult to argue that your dollars would be better served paying off your mortgage unless you are on Step 9, pre-pay low-interest debt. You should aim to be completely debt-free by retirement, and after age 45 you can begin thinking more seriously about pre-paying your mortgage.
Are there disadvantages to paying off mortgage early? ›
If you pay off your mortgage early, you'll no longer have any mortgage interest to deduct on your tax return if you itemize your deductions. This change is most likely to affect you if you have a large mortgage, a high interest rate—or both—-and your annual interest payments are substantial.
How much to retire with no mortgage? ›
By age 40, you should have accumulated three times your current income for retirement. By retirement age, it should be 10 to 12 times your income at that time to be reasonably confident that you'll have enough funds. Seamless transition — roughly 80% of your pre-retirement income.
How much do you need to retire if your mortgage is paid off? ›
If you pay off your mortgage and debts before retiring, you could live on smaller portion of your preretirement income. Based on this rule, if your annual preretirement income was $100,000, you need $80,000 a year in retirement to cover your expenses.
