Pros and Cons of Paying Off Your Mortgage Before Retirement

Can I pay off my mortgage early?

The simple answer is, yes, you absolutely can pay off your mortgage early. Many conventional loans have no prepayment penalty, and some loans, such as FHA loans, VA  loans and single-family USDA loans, explicitly ban the inclusion of a prepayment penalty. For the small percentage of mortgages with a prepayment penalty, the FDIC sets a legal cap on the maximum amount and time frame.

Assume that your mortgage has an outstanding balance of $100,000. If your agreed-upon prepayment penalty is 2%, and you pay it all in year one, you would be assessed a penalty of $2,000 ($100,000 * 0.02 = $2,000). You can usually deduct this payment on your taxes as mortgage interest.

Pros of paying off your mortgage before you retire

There are a number of benefits to paying off your mortgage before you retire, such as:

• Saves money in interest: Even if you pay off the mortgage a few years before you retire, you will save money by not allowing the remaining principal to continue accruing interest.
• Eliminates a monthly payment: For many people, the ease of mind provided by erasing a major recurring expense is a significant benefit. Especially for older adults on a fixed income, reducing monthly financial outlay can be a powerful motivator.
• Increases equity: Paying off your mortgage before you retire means that you are the sole owner of your home. So, in the event that you decide to sell, you won’t have to worry about a portion of the sale going to cover your mortgage.
• Protects your savings and investments: Eliminating a monthly payment has several tangible benefits. You can invest the money that otherwise would have gone toward your mortgage or save it for unforeseen needs like emergency medical expenses. If your retirement income will come from your investment portfolio, cutting monthly expenses may also allow you to reduce your withdrawal rate, keeping more money in investments to act as a cushion against market downturns.
• Allows you to spend the money elsewhere: If you already have adequate income for your regular expenses and a health emergency fund, you can spend the money you save by getting rid of your mortgage payment on leisure, hobbies or travel.
• Reduces stress: For many homeowners, fully paying off mortgage debt provides peace of mind and a sense of security and accomplishment. Just be careful that your newly freed-up cash flow doesn’t lead to “lifestyle creep” — the habit of increasing your spending when you have more money on hand.

Cons of paying off your mortgage before you retire

While there are benefits to paying off your mortgage before you retire, there are also some possible risks and downsides. Carefully reviewing the potential cons and comparing them with the pros will help you make the most informed decision.

Withdrawing funds from an IRA before age 59 1/2 may result in a 10% tax penalty.

Some drawbacks to paying off your mortgage before you retire include:

• Prepayment penalties: As unlikely as it may be, the possibility of needing to pay a prepayment penalty is a legitimate risk that a homeowner should consider before paying off their mortgage.
• Loss of tax deductions: There are many tax benefits associated with homeownership, including the ability to deduct your mortgage interest payments on your taxes.
• Potential income spike: Liquidating pretax retirement accounts to pay off your mortgage loan could raise your taxable income. This could put you in a higher tax bracket, increasing your tax liability. It may also trigger a higher-income Medicare premium surcharge or disqualify you from income-based assistance programs.
• Depleting your savings/emergency fund: While paying off your mortgage may seem like a good way to help your retirement, it can have the opposite effect if you deplete your retirement savings to do so. In addition, you may risk being unable to cover emergency expenses, medical or otherwise.
• Reduced liquidity: While possible, it is harder to access the equity in your home than to access equity stored in the form of investments or a savings account.

Paying off your mortgage early vs. investing

Another key consideration when deciding whether to pay off your mortgage early is how it compares with investing for retirement. If your mortgage interest rate is low, you might be better off investing extra funds in retirement accounts like a 401(k), traditional IRA or Roth IRA.

Paying off a mortgage early saves on interest, while investing has high-term potential return.

Retirement investments offer compound growth, tax advantages and, in some cases, employer contributions. Over time, the return on those investments may exceed the amount you would save in interest by paying off your mortgage early. For example, if your mortgage interest rate is 4% and your investments average a 7% return, you would come out ahead by investing.

However, this strategy assumes you are comfortable with market risk and that your retirement accounts are accessible without triggering penalties. It also depends on your financial goals and how much peace of mind you place on being mortgage-free.

Ultimately, the right decision hinges on your financial situation, retirement timeline and risk tolerance. You might even consider a hybrid strategy, where you contribute aggressively to retirement accounts while making occasional extra payments on your mortgage.

How to make extra payments on your mortgage

Making extra payments toward your mortgage allows you to pay off the loan more quickly than you might otherwise. This can be done by paying a one-time lump sum toward your principal, making smaller payments on top of your monthly mortgage payment or changing to a biweekly payment schedule.

• Making regular extra principal payments can reduce your balance while preserving liquidity and gradually reducing your loan term length.
• Switching to biweekly payments gives you one full additional payment per year; instead of 12 full payments, you’ll make 26 half-payments, or 13 full payments annually.
• A large lump-sum payoff may yield greater interest savings than a more incremental strategy, but it may reduce your overall financial flexibility because it ties up more money in equity.

The best strategy for you depends on your retirement horizon, as well as your available funds and monthly cash flow needs. You can also take a more flexible approach by putting any windfalls, such as a tax refund or bonus, toward your principal.

Alternatives to paying off your mortgage before you retire

Some people choose not to pay off their mortgage before they retire due to the availability of other options. Each alternative is distinct, with unique pros and cons that you should consider before making a decision.

Some alternatives to paying off your mortgage before you retire include:

• Refinancing: Refinancing is a process in which a homeowner replaces an existing mortgage with one with different terms — often a lower interest rate or a longer term. If your retirement is still far in the future, refinancing to a mortgage with a longer term and lower monthly payment may help you free up funds for higher-yield investments. Conversely, if you’re close to retirement and can handle higher payments, you might consider refinancing to a shorter term that aligns with your retirement date.
• Recasting: Mortgage recasting involves making a lump sum payment toward your principal. Your lender then recalculates your loan based on the new lower balance, reducing your monthly payments. Unlike refinancing, recasting keeps your mortgage’s same rate and term. Recasting may be a good option if you have a good interest rate you would like to keep but you still want to lower your monthly payment.
• Home equity loan: Taking out a home equity loan or line of credit (HELOC) might be a good option for homeowners who have built up equity in their homes and can get a low interest rate.
• Reverse mortgage: Generally, only homeowners aged 62 and over can apply for a reverse mortgage, which provides a lump sum payment or regular payments in exchange for home equity. The loan isn’t repayable until you sell the home or die. A reverse mortgage can have serious downsides, though, such as affecting what you pass down to heirs.
• Downsizing: Selling your home and using the proceeds to purchase a smaller, less expensive house, condo or apartment can lower or even eliminate mortgage payments without the need to tap into savings. This can be a good option for homeowners who want to reduce their upkeep responsibilities alongside their payments.

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FAQ

Bottom line

There are many reasons a person might opt for or against paying off their mortgage before they retire. Possible benefits include additional peace of mind and the ability to redirect those funds to other expenditures. However, risks include the incurrence of penalties and the depletion of savings and emergency funds.

In the end, there is no correct answer as to whether or not you should pay off your mortgage before you retire. However, it may help to consider these rules of thumb:

• It may be a good idea to consider paying off your mortgage early if you have a high-rate mortgage or if you plan to stop working soon and your savings are on track for retirement.
• It might make more sense to keep paying your mortgage for now or choose a gradual strategy to speed up payoff (such as biweekly payments) if you have a low-rate mortgage, you don’t plan to retire for a while, your emergency fund is limited or you’re behind on saving for retirement.

Each individual’s or couple’s mortgage payoff decision depends on their number of years to retirement, current mortgage interest rate and risk tolerance, among other factors. If you’re on the fence, consider speaking to an experienced financial professional who can help you explore how paying off your mortgage fits into your broader retirement income plan.