For many people approaching retirement, paying off the mortgage is one of their biggest financial goals.
After all, wouldn't retirement feel better without a monthly mortgage payment?
There's certainly something to be said for entering retirement debt-free. But paying off your mortgage isn't always the best financial decision, especially if doing so means using a large portion of your retirement savings.
Sometimes keeping your mortgage leaves you in a stronger financial position.
Let's look at an example.
Should you pay off your mortgage before retirement?
Meet Sam and Sally. They're both 60 years old and getting ready for retirement.
They've accumulated approximately $1.4 million in retirement and investment accounts:
-$1 million in traditional IRAs and 401(k)s
-$300,000 in a taxable brokerage account
-$100,000 in Roth accounts
They also have a $300,000 mortgage at a fixed interest rate of 3.25%, with about 15 years remaining.
Their monthly principal and interest payment is approximately $2,100.
Sam and Sally would love to eliminate that payment before retiring. Doing so would reduce their annual expenses by roughly $25,000.
But before they write a $300,000 check, there are three important things to consider.
1. What's your mortgage interest rate?
The interest rate makes a significant difference in whether paying off your mortgage makes financial sense.
For Sam and Sally, paying off their mortgage would eliminate interest at 3.25%.
That's a guaranteed savings, but it may not be the best use of their cash.
If savings accounts or short-term Treasury bills are paying more than their mortgage rate, keeping that money in savings or Treasuries may make more sense, especially after comparing the tax consequences.
Of course, those rates can change, and the interest earned may be taxable. Meanwhile, their mortgage rate remains fixed at 3.25%.
Now consider someone with a mortgage rate of 6% or 7%.
Paying off that mortgage becomes considerably more attractive because the interest savings are much greater.
The point is that not all mortgage debt should be treated the same way. The interest rate matters.
2. How much money will you have left after paying off your mortgage?
This is one of the most important questions, and it's often overlooked.
Consider two retirees who each owe $100,000 on their mortgage.
The first has $300,000 in readily available savings. Paying off the mortgage leaves $200,000 available for unexpected expenses and other retirement needs.
The second has only $110,000 in savings. Paying off the same mortgage leaves just $10,000.
Same mortgage balance. Same interest rate. But two very different financial situations.
Now return to Sam and Sally.
They could use their $300,000 brokerage account to eliminate their mortgage.
However, that would mean giving up nearly all the money in an account they can readily access without making large taxable IRA withdrawals.
What happens if they need a new roof, face unexpected medical expenses, or encounter a significant market downturn?
Their home equity has increased, but their liquid savings have decreased.
Getting that money back could require selling the house, borrowing against it, or withdrawing additional funds from retirement accounts.
And there's another consideration. Without their brokerage account, more of their future spending may need to come from traditional retirement accounts, potentially increasing their taxable income.
Having a paid-off home is valuable, but so is having financial flexibility.
3. Which account will you use to pay off the mortgage?
Where the money comes from can have a major impact on your taxes.
Suppose Sam and Sally decide to leave their brokerage account untouched and withdraw the $300,000 from their traditional IRAs instead.
Because their retirement accounts contain pretax money, those withdrawals would generally be subject to ordinary income taxes.
To have $300,000 available after taxes, they'd need to withdraw considerably more than $300,000.
That large withdrawal would push more of their income into higher tax brackets.
It could also create other consequences.
For example, if they're purchasing health insurance through the Affordable Care Act Marketplace before becoming eligible for Medicare, additional income could reduce their premium tax credits.
And for someone closer to Medicare eligibility, a large income increase could result in higher Medicare premiums two years later through the Income-Related Monthly Adjustment Amount, commonly called IRMAA.
Even using their taxable brokerage account can involve capital gains taxes, depending on the investments sold.
This is why paying off a mortgage isn't simply a matter of comparing your mortgage balance with your investment accounts.
You need to consider the tax consequences and how the decision affects your future retirement income.
When paying off your mortgage before retirement makes sense
There are also legitimate reasons to pay off a mortgage.
The most obvious is improved cash flow.
Without their $2,100 monthly mortgage payment, Sam and Sally would need approximately $25,000 less each year to support their lifestyle.
That can be especially helpful during a market downturn because they wouldn't need to withdraw as much from their investment portfolio to cover expenses.
And there's another benefit that's difficult to measure financially: peace of mind.
Some people simply feel more comfortable knowing they own their home outright.
If the retirement plan works comfortably either way, there's nothing wrong with placing a high value on being debt-free.
The key is understanding what you're giving up to accomplish that goal.
You don't have to make an all-or-nothing decision
Paying off the entire mortgage immediately and keeping it for another 15 years aren't your only options.
You might choose to make additional principal payments over time, pay off a portion of the balance while maintaining adequate savings, or simply continue making the scheduled payments.
The right approach depends on your mortgage rate, available savings, tax situation, and overall retirement income strategy.
Before making a large mortgage payoff, compare your retirement plan both ways.
What does retirement look like if you keep the mortgage? And what changes if you pay it off?
The goal isn't necessarily to enter retirement with no debt.
It's to have a retirement plan that provides financial security, flexibility, and the confidence to enjoy the years ahead.
Sometimes that means paying off the mortgage. Other times, it means keeping it.