Transitioning into retirement without a mortgage can reduce stress, improve cash flow and increase your sense of financial security.
But while everyone would love to be debt-free, there are many factors to be considered before making extra payments or pulling from your savings to pay off your mortgage.
You need to maintain adequate liquidity to cover living expenses, an emergency fund of at least four months of expenses and major planned expenditures such as new vehicles, home improvements and tuition for your children. Once you make the extra mortgage payments, you will lose access to those funds without refinancing or taking out a home equity loan.
If you have other high interest debts on credit cards, vehicle loans or student loans, you should pay those before making extra payments on your mortgage.
If you have the funds to make extra payments, how would you spend the money otherwise? Would you increase your discretionary spending, put it into savings or invest the money? If you are likely to spend the money, extra mortgage payments can serve as a forced savings.
However, if you plan to invest the money or are thinking about pulling money from investments, you need to weigh the benefit of paying less interest with the loss in return on your investments. Your portfolio is probably invested in a mix of stocks and fixed income, so you need to compare the interest rate of your mortgage to the anticipated return on your portfolio. Keep in mind that paying off your mortgage is risk-free and investing in the stock market comes with significant risk and volatility. You need to decide how much return you are willing to forgo for the security of paying off your mortgage.
Consider the tax consequences of paying off your mortgage. You want to avoid pulling money from your retirement account to make extra payments because you will have to pay regular income taxes on the withdrawal and may have to pay a 10% penalty if you are under 59½.
Also consider the loss in tax deductibility of mortgage interest as you make extra payments on your mortgage. With the recent increase in the standard deduction, this may be of less concern.
Keep in mind that in the later years of a mortgage, most of the payment is principal.
You also need to consider how much you are contributing to your retirement plan. If you are not maximizing your contributions and you have a high income, you may need to maximize contributions rather than making extra mortgage payments to get the tax break. You also need to contribute enough to meet your retirement goals and take advantage of any employer match.
Jane Young is a fee-only certified financial planner. She can be reached at [email protected]