Should I Pay Off My Mortgage Before Retirement?
Part of the things that you've got to look at there is timing, right? Are we retired or not? How far from retirement are we? What is our interest rate? What is our loan terms look like?
Jacob:And then what is the emotional component of all of this? How does that factor into our decisions? Welcome to Retirement Answers, a podcast built to answer your most pressing retirement questions. If you're someone who's either thinking about retirement or already in retirement, well, you're in the right place. Hey there, my name is Jacob Duke, and each week I'll be walking through different tips and strategies to help you succeed in retirement.
Jacob:So let's go ahead and get started with today's show. Should you pay off your mortgage before retirement or not? That's the question we're gonna talk through today here on Retirement Answers. Welcome back to another episode. My name is Jacob Duke.
Jacob:I'm your host as always. And let's talk about that. Let's talk about whether or not you should pay off your mortgage before retirement. This is always a big question for for anyone who's approaching retirement. And the easy answer in your head might be, well, duh, Jacob, of course, you should pay off your your debts and your mortgage before you go into retirement so that you don't have that to pay for those retirement years.
Jacob:And I couldn't agree more because whenever I'm analyzing whether or not someone can retire, the first thing that I look at is are they debt free? I'm talking everything. No mortgage, no cars, no credit cards, no HELOCs, nothing. And if there's no debt, retirement is almost always possible pretty much regardless of how much money you have. But does that mean that you, you specifically, should pay off your mortgage before you retire?
Jacob:Maybe, but there are also some important considerations that you've got to evaluate before you do so. So in this episode, we're going go through a few different things that I think are important to look at and evaluate before you go ahead and just pay off your mortgage because it could negatively affect you in some different areas if you do that without analyzing things first. So the first thing we're going kind of talk through is the importance of your amortization schedule and how that impacts your decision to pay off your mortgage or not. We're going to look at the cost benefit analysis of interest earned versus interest paid. So basically, I invest this money at a higher rate than what I'm paying on my mortgage?
Jacob:We're going to talk about why I think cash is king throughout life, but specifically in retirement, why I think cash is very important to have on hand. And also, we're going talk about the psychological side of having no debt, which is really what a lot of people are fighting for. How can I just be debt free and then I'll have this mental hurdle, this mental weight just eliminated from my life because I have no more debt? And then finally, we're gonna look at a couple different quick client scenarios where different decisions might be made when we evaluate these different considerations I just talked about. We're gonna make maybe different decisions when it comes to paying off their mortgages or not.
Jacob:So let's go ahead and just kinda jump into like why, you know, why would you wanna pay off your mortgage in the first place? Well, the first reason is simply, you know, you're trying to reduce your baseline expenses, right? Because if you've a mortgage, a car payment, or maybe some sort of HELOC that you've gotta pay off, you've got a baseline of fixed expenses every single month that you must take out of your account somewhere. You must have an income to support. So if you pay off your mortgage, what you're gonna do is you're gonna lower that baseline expense down to basically just whatever you need to spend for food, gas, all the essentials, the utilities, everything you need month to month that doesn't, you know, pay for debt.
Jacob:So by not having a mortgage on the table, you're reducing your baseline expenses. That might be the first reason to pay it off, because in retirement, the biggest equation is, well, how much money do I have and how much do I need to spend? And does the math work out in such a way that I'll never run out of money? So if we need to lower your expenses, obviously paying off debt could do that, but there's a catch, you've got to take that money to pay off the debt from somewhere. So that's the hard part.
Jacob:Another reason to pay off your debt is because it might have a high interest rate. Now, this is a little bit tougher depending on when you purchase your home or perhaps you refinance because in 2020, 2021, and part in the beginning of 2022, you had really, really low interest rates. Many people, many of my clients have, rates below 3%, which is really unheard of historically, and I'm not sure if we'll ever see that again, but that's a hard rate to give up. It's almost like free money to leverage your house and keep your assets more liquid and in your possession by not paying off the house. It's kind of cheap to do that at an interest rate so low.
Jacob:So if you have a higher interest rate, perhaps you did not refinance and you purchased ten, fifteen, twenty years ago, or maybe you purchased after the lower rate. So here in the last couple of years, your rate might be higher. You might think about paying it off then. So that's a reason why you maybe wanna pay off your mortgage is because you might have a higher interest rate than you would like. A big reason that many people like to do it, in my opinion, this is one of the most compelling reasons, is simply just to have peace of mind, right?
Jacob:Debt is sometimes helpful for people from a mathematical standpoint, we can make the numbers work, and it's actually beneficial to have debt in some instances from a math perspective. But I would argue that debt in almost every scenario doesn't help you mentally or psychologically or emotionally. To have more debt on your balance sheet does not make you feel better most of the time for most human beings. After all, we are human, and so having this obligation that's kind of lurking in the background forever is not something that we like. So a lot of people want to just eliminate all debt, especially before retirement, so they have this peace of mind knowing that, hey, I can wake up every day, I don't owe anyone anything, and I can just go enjoy my life, spend it with the people I love, doing the things that I love to do.
Jacob:So those three big things are kind of the reasons that you would want to pay debt off. Now, why would you not want to pay debt off? Now, why would you not want to pay debt off? Well, maybe you're not yet retired or maybe you're a few years out and you really need to catch up on your retirement savings, meaning investing your money could actually lead to a greater outcome in the end compared to paying off your debt right now today. Because if you pay off your debt right now today with all of your extra earnings, what you're gonna do is you're going to eliminate potential growth in your accounts and in your investments.
Jacob:So you might not be able to retire as soon as you would like because you have no money to retire. Even though you've got a paid off mortgage, you don't have any money. So it kinda doesn't help you out a ton. So that's one reason you gotta do some catching up on retirement savings. Another reason you might not want to pay off your debt immediately anyway is maybe you don't have enough cash on hand.
Jacob:Again, I mentioned it earlier, cash is king, and I love cash, especially in retirement, even throughout life, because what happens is if you don't have any cash available to you in different instances or moments throughout life, what you're gonna have is no opportunity. Meaning if you wanted to invest in a new thing, right, and you don't have any cash, well, can't go invest in it. If you had an emergency come up, well, if you don't have any cash, then you can't take care of it or pay for that emergency without using credit or loans or debt. So, having cash on hand is huge, especially in retirement, because I talk about this a lot, but we want to have at least two years worth of living expense needs in cash in retirement, and that's really to provide a buffer for the market volatility that will happen. It's not a matter of if it's gonna happen, it's a matter of when it's gonna happen.
Jacob:And so, for us in retirement, what we're trying to do is we're trying to preserve assets and grow slightly. We're not trying to beat the S and P 500. We're not trying to make you millions of extra dollars on top of what you already have. What we're trying to do is we're trying to mitigate risk. And so having cash on hand mitigates the short term risks of having to sell whenever you otherwise don't need to sell.
Jacob:So low cash is a reason you might not wanna pay that off. It might be more beneficial to have a little bit of liquidity as opposed to no debt. Another reason you might not need pay your mortgage off is because you simply have other debt, whether it be car loans, credit cards, HELOCs, anything else outside of a mortgage or a traditional mortgage, you would probably wanna take care of those things first, because at least the mortgage is backed by an asset that's valuable as opposed to a consumer debt where you don't actually get anything out of the deal in the end. Take care of those first, because they typically have higher interest rates. So those are a few different reasons that you might want to pay off or not to pay off your debt.
Jacob:But let's talk really quickly about some of the different considerations or factors kind of in this. And let's start with a few different factors that you've got to consider here to evaluate whether or not paying off debt is something that you should do. The first thing I want to talk about is is an amortization schedule. What this is, is this is tied to your mortgage. If you're unaware, what happens is whenever you get a mortgage payment, let's call it 1,500 a month as your mortgage payment, not all $1,500 is actually going to be paying off your mortgage in terms of the principal amount that you owe.
Jacob:What you're gonna do is you're gonna pay a portion to the principal, so you're paying off your house in that way, and then a portion of it is actually going to interest what the bank loans you, they're charging you for that money. So you could be paying half towards the principal and half towards interest. You could be paying 25% towards principal and 75 towards interest, or 75% towards principal, and then 25% towards your interest payment. Now, the catch here is how far along in this cycle are you of in terms of your amortization schedule, right? If you bought a house right now today for a 30 year mortgage and the rate was 5%, 75 to 80% of your payment is not going towards the principal, it's going towards interest.
Jacob:They front load your interest payments so that you're paying more interest in the first fifteen years of that thirty year mortgage compared to the last fifteen years. So what happens is is you actually are not paying as much of your principal balance off as you might think, and so you're paying more interest on the front end. So how do we need to evaluate this? Well, if you bought a house two years ago, and you're trying to retire next year, and it's a $500,000 mortgage left on the balance. Well, if you run that out over thirty years, you've got a long time before you pay that out, right?
Jacob:You could actually not even be here anymore by the time that needs to get paid off. But the key here is that your amortization schedule is not working in your favor. So you're gonna be paying interest on this house for the first fifteen plus years at a higher amount than you would be paying towards the principal. That's not a good thing from a cost perspective. So now, if counter that with saying, hey, we bought a house twenty five years ago, and we're five years out from paying this thing off, Should we pay it off immediately right before retirement or should we just hold on to the mortgage and pay it?
Jacob:Well, at this stage, five years out from being completely paid off, you've been paying on it for twenty five years and your monthly payment's $1,500. Well, out of that $1,500 a month, guess what? Probably $1,200 of that is going to be going towards the principal, which means only 2 to $300 is really going towards interest, which is a really small price to pay to have extra cash on hand in your bank account or in your IRA. So that's two examples that are kind of opposite of each other, depending on when you got your mortgage or what your amortization schedule looks like, how much interest versus principal are you paying on a monthly basis, that's going to help dictate your decision around should you pay it off or not. If you got another twenty five years on your mortgage to go and you're thinking about retirement in the next couple of years, having that debt paid off sooner is actually going to help you save on interest over that twenty five years, which means you're going to give up some cash now to pay it off, but you're not going be paying hundreds of thousands of dollars into the future in interest.
Jacob:Now, the opposite of that, again, is if you are only a couple years out from being done with a mortgage and you're also about to retire, maybe don't worry about paying off that mortgage just yet. Keep a little bit of liquidity, keep a little bit of cash on the side so that you have some slush fund or rainy day fund as you enter retirement. Again, wanna have two years of cash as we enter retirement and throughout retirement. So if you have to give up that two years worth of cash in order to pay off your mortgage, in that situation, I'd probably say, hey, hold on to the mortgage, keep your cash, that's probably more valuable in this moment specifically. So that's the first thing to look at.
Jacob:Look at your amortization schedule, see where you're at in terms of how much you're paying in every month in interest versus principal. What does that look like? If you're paying a lot more towards principal, maybe paying off that mortgage is not the best idea, at least at this point in time. And that leads directly into the next thing we've got to evaluate is how much cash or liquidity do we have? If we don't have much liquidity, if we only have $10,000 in a bank account, if we don't have much cash in our IRAs or much room to have cash in IRAs, we probably want to hold on to what we have rather than paying off a debt.
Jacob:Because again, not having money outside of the stock market opens you up to sequence of return risk, meaning if you retire today with minimal cash and the market goes down 40% over the next two years, well, and you only have stock or bonds or even down, let's say 15%. Well, what you've got then is you've got to sell your assets at a loss to create income for yourself in retirement. So by not having cash on the sidelines that you can pull from in those different scenarios when things are not going well, you're depleting your overall retirement nest egg that much more because when you take that money out, it's not going to recover when the market recovers. That's the catch. We've gotta be able to have money on the sidelines to take care of ourselves when things aren't going well, allow our investments to actually recover so that we're not selling in a loss and locking in those losses forever.
Jacob:You gotta remember, cash is king throughout your life, but especially in retirement. So, again, if you don't have much cash or liquidity, paying off your house is actually might not be the best thing because the value of having cash on the sidelines is probably more valuable to you specifically than paying off a mortgage today because if you can extend out those payments, let's say you owe $100,000 on your mortgage and you have $100,000 in cash and you still have, you know, ten years on that payment schedule, well, stretching out that $100,000 payment over ten years is actually helpful because you get to keep your $100,000 in cash for your rainy day or different hard times in retirement, and you can still meet your monthly payments over that ten year period. So extending that out actually helps you eliminate some risk rather than paying it off all right now today. The next thing you've got to evaluate is this cost benefit analysis of interest earned versus interest paid. So really what this is is Jacob, can I go invest my money and get a higher rate of return than what my mortgage rate is?
Jacob:And perhaps the answer is absolutely, you might be able to, especially if you've got a low mortgage rate, again, 3% or less, or even 4% or less. If you can go find, if you have a mortgage rate like that, you can probably invest the money that you would use to pay it off. You can invest that better and get a higher return. Even that right now in cash, high yield savings accounts, you can get four and a half to 5% depending on when you listen to this. And what that does is that means there's there's an interest rate arbitrage, if you will.
Jacob:You you can actually make a little bit more money with your money sitting in a bank account rather than having the debt paid off. So it makes you money to not pay off the debt. Now, that's one thing to look at. Now, other factor is what is your expected investment return? So are you gonna leave this in cash, which is if it's in a money market, rate of return is gonna fluctuate, your interest rate's gonna fluctuate with the market over time, so it could go up or it could go down, so you could actually be losing money in this scenario in the future if you don't pay your mortgage off because cash rates could go down.
Jacob:You also have to think about should I be investing this money that I could pay off the house with? Should I invest that in the stock market for some anticipated return of eight, nine, 11%? That's a question you gotta ask yourself. Something else you gotta factor in here is your tax considerations, right? If you invest in a high yield savings account getting 5%, any interest that you receive in that account is gonna be taxable this year, and it's gonna be taxed as normal income.
Jacob:So if you're in a really high tax bracket, let's call it 24% or more, and you make $10,000 this year in interest on your high yield savings account because you're keeping it there to make more money than what your mortgage rate is, well, you've got to factor in that you're going to pay at least 24% at the federal level, maybe even more at the state level, depending on your state, you've got to pay tax on that $10,000 which means your real return is actually a lot lower than what you expected. So you've got to factor in your taxation on your investments or your interest that you're going to earn on your cash or whatever you're investing in. So you've gotta do the math here. You've gotta see, hey, what is the benefit of investing this money in my timeframe? Do I have a long time before retirement, meaning I have time to grow these assets?
Jacob:What does it look like in terms of the current investment environment or economic cycle? Are markets devalued? Are they down? When that would create a, you know, a good buying opportunity, or are they elevated, which means I might not need to buy in because the expected future return of an elevated market is lower than that of one that has been devalued. So you gotta factor all these things in whenever you're evaluating, hey, do I pay this mortgage off?
Jacob:Do I not? You gotta say, hey, what can I get for my money outside of paying it off? What's the interest rate? What's the rate of return I could get? And is that higher after tax compared to that of what my interest rate on the mortgage is?
Jacob:And then finally, one of the big things that I think you just have to consider in all of this, and I actually allocate more weight towards, is the emotional or the psychological components of all of this. To have no debt is so freeing for us as humans, right? Whether we know it or not, I think once it's all paid off, we we have this feeling of elation that's like, my goodness, how did I live any other way? And and what we've got is is we get used to having debt. It's just a normal part of being an American, I feel like for most people, if you look at the stats on it, everybody is in debt.
Jacob:Probably 10% of the population is not in debt, which is not a good thing, whether it be just a normal mortgage, credit cards, HELOCs, just personal loans, whatever it might be, everybody has some sort of debt. And in a rare instance, people don't have debt, they always say, not having debt is the key to my wealth building. Not having debt is the key to feeling free. Not having debt is the thing that allowed me to sleep at night knowing I don't owe anyone anything. So I would say that the biggest consideration in all of this, yes, we've got to pay attention to the math.
Jacob:Yes, we've got to think about what are the ramifications, positive or negative, of paying this off, should we or should we not, but I think you should allocate the most weight to your emotional well-being. How much better would you feel if you paid off your mortgage, if you had no debt? What would that look like in your life? Would you feel more inclined to go on the vacation you wanna go on? Would you feel more able to go pay for your grandkids college?
Jacob:Would you feel better about donating more money to the local church or food bank or whatever is important to you? Like those are the things that I think that are most important, right? And if you don't have any debt, it actually frees you up to go do those things and you'll be more fulfilled by doing that. So again, I think the biggest thing you have to focus on here is yes, you've got to do the math, but the biggest thing is how much better would you feel emotionally, mentally and psychologically if you did not have any debt to worry about, right? I'm 100% confident that it would free you up to go enjoy life the way that you want to go enjoy life.
Jacob:So focus more on the emotional side, the psychological side and ask yourself the question, what would it feel like to have no debt, no mortgage? What would that feel like? Would I live life the same? Would I appreciate it that much more? Would I feel great about it?
Jacob:Would I feel this sense of relief? If the answer is yes to some of those things, really consider paying it off, especially if you're able to. Some people are not in a position to pay off their mortgage, and that's totally fine. We've gotta do the right thing mathematically, and we've gotta do the prudent thing to make sure that you are not doing something otherwise that you shouldn't be doing. And so with all of that kind of understood, I wanna talk through a couple different scenarios really quickly where two different outcomes might come into play.
Jacob:One person might decide to pay off the mortgage and one person might not. So the first one is, let's say your, one spouse is retired, one spouse is still working, you've got about $80,000 left on a mortgage and your cash flow monthly is enough to meet the mortgage payment, but you don't really have much left over. Now, remember, one spouse is still working, you've got a decent amount of assets, about 700,000 in assets, And you've got to consider, hey, when do we pay this off? Now, a big thing here is going to be your Social Security income. So in this scenario, let's say the husband and wife, they've got Social Security income of about $4,000 coming in a month and their total expense need is about $5,000 if they don't have a mortgage payment.
Jacob:So in that scenario, they've gotta come up with an extra thousand dollars every single month to meet their retirement expense and needs. Now that's including a few vacations and different things like that they wanna do locally. So not extravagant spending or travel at all, but it's just what they want to do. So in this scenario, having the debt paid off actually allows them to not pull as much money from their retirement accounts, meaning they can have lower cash reserves because they don't need as much annually, again, a thousand dollars a month, dollars 12,000 a year is their minimum expense need, we might wanna hold just a touch more than that. So if you multiply that by two, that's two years, that's twenty four, we'll round up to $25,000 in cash they've gotta have to meet their two years cash reserve, Might wanna have a little more than that, we can even bump it up to 50, but let's say they take the $80,000 they need out of their $700,000 of assets, we'll round that down to 600,000 total.
Jacob:Well, got $600,000 If we do the math on $600,000 divided by $1,000 a month or 12,000 a year, guess what? We've got a long time before they run out of money. So that actually secures their retirement, gives them more ability to live a life of enjoyment and fulfillment in retirement, not to worry about money as much because their spending, once they have Social Security turned on, their spending is gonna be so minimal out of their portfolio that they don't have to worry about anything. Now, if they kept the mortgage, the mortgage payment's about $1,700 If they kept the mortgage, guess what? They have an additional $1,700 they have to pull from their portfolio.
Jacob:What this does is is this opens them up to this sequence of return risk, meaning if the market goes down by 30%, they're gonna have to keep the mortgage longer because they won't be able to pull money out of their investments because they wouldn't wanna sell at a loss. So it actually keeps that debt there a little bit longer. And so in this scenario, you could probably go either way, but the wife was like, hey, I want to be debt free. I just want to be done with this stuff. I don't want to think about it anymore.
Jacob:I don't want the weight of it anymore. So if it's a toss-up, again, allocate more weight towards the emotional and psychological side of it. The easy decision is, is yes, let's pay this thing off. It's gonna be minimal taxes, we can split the payments over two tax years so that we can lower that tax bill for you, and then boom, we're done with debt. We have minimal expenses every single month out of your portfolio in retirement, and your assets at $600,000 are gonna be more than enough to meet your lifetime expense needs.
Jacob:Now that's one scenario. Now the other scenario is, let's say we're about ten years out from retirement, we've got about 210,000 left in a mortgage, the house is worth about 800, We've got over a million dollars already saved and we're chunking money away and saving it every single month. The thing here that we've got to evaluate is, is what would we be giving up if we don't invest that money over the next ten to fifteen years? How much money will we give up to not invest that money? So if we took all of our extra and we saved it and paid that down on the mortgage and we didn't invest that money, how much better would that benefit us?
Jacob:And the answer is is it might not because what you're giving up on a two and a quarter percent interest rate on a fifteen year loan is, is you're giving up the fact that you could make 10 plus percent over the next ten, fifteen years if you invest that money appropriately. Now, obviously, we don't know what the future holds, and I'm not saying that I can get you some specific investment return, but what I am saying is, is there is a trade off. And so for this couple, it's, hey, we're going to actually not pay off this debt right now. We're not going to attack it right now. We're going to just pay it off over the life of the loan, which again is only a fifteen year mortgage, it's not a thirty year mortgage.
Jacob:So more of our monthly payment is going towards principal automatically and we're paying it down faster. And so what we're doing there is we're not paying it off so we can invest and make a higher return and secure our retirement in that way. Another factor in this is neither of them actually cared that they have the debt. It's not an emotional burden for them. They're like, hey, we understand it's a part of our life right now, and it doesn't feel bad at all.
Jacob:We're totally fine paying it. Our monthly income is more than enough to meet that, plus max out retirement accounts and everything else. So it's not like it's a burden. So we don't really care to pay it off, especially since the interest rate is so low. So that's two different scenarios.
Jacob:And part of the things that you've got to look at there is timing, right? Are we retired or not? How far from retirement are we? What is our interest rate? What does our loan terms look like?
Jacob:And then what is the emotional component of all of this? How does that factor into our decision? And so again, two different outcomes because of the details of the situation that are at play in each of those different scenarios. So hopefully today's episode helps you see that, yes, paying off debt is very helpful for securing your retirement, but when and how you pay it off is also very important. We don't wanna give up too much to pay it off immediately and miss out on something else.
Jacob:And so we've gotta consider all these different factors, all these different things around your specific scenario, and this is why I tell people all the time, you've got to have a tailored and specific and unique retirement plan for you and your situation. Yes, all the principles I can talk to you about, they all apply to everyone, but how we implement solutions for those different principles and ideas, that's the thing that's different for each person. So if you're someone who's like, hey, I need a personal retirement plan, I need somebody to help me and guide me on all these different things, I don't feel like I'm doing the right thing or I just don't want to mess something up. Well, I've got good news for you because in 2025, me and my firm River Tree, we are taking on new clients in 2025 and hoping to help more people secure their retirement, feel confident in their plan and understand that money is about more than just money. So, if we can help in any way, reach out.
Jacob:There's a link down in the description of this podcast where you can go and schedule a quick free intro call with me and, we can get to know each other a little bit, learn more about your situation and see if I would be a good fit to help you on your retirement planning journey. So if that's of interest to you, go ahead and do that. Also, if you're benefiting from the show, feel free to share it with other people. Feel free to share it with a friend, family member, let them know about it. That way they can learn from these same ideas and topics and conversations we're having.
Jacob:Also, if you're enjoying the show, go ahead and leave a rating and review there on Apple Podcasts or on Spotify. It helps other people just like you find the show and benefit from these same conversations. So thank you for tuning into this week's episode of Retirement Answers. I hope you have a great rest of your week and we will be back here again really soon. Hey, it's Jacob again, and I wanted to extend a quick offer to you.
Jacob:If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net. And I'd love to answer that question for you right here on the show. Also, wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode.
Jacob:Look forward to talking with you again next week.
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