For most people, a home is the biggest single purchase that they will ever make. When you are in the early days of home ownership, and you are simply excited to have your name on the deed, paying the mortgage each month doesn’t feel like a burden. In fact, it can almost be exciting knowing that you are building equity and your own personal net worth.
After a few years, though, the euphoria of finally being a homeowner wears off, and as you write the monthly check to the mortgage company, you start to feel that you’ll never be done. If you are nearing retirement age, that feeling might even be stronger. You start thinking that it would be nice to have that debt taken care of before you bid adieu to your career and move in to your next phase of life. After all, without the monthly mortgage payment, you don’t need as much cash to retire on — and you might even be able to retire sooner.
If that line of thinking sounds familiar, stop right where you are. When it comes to your mortgage, your emotions could lead you to make a poor financial decision, one that will put your long-term financial security in danger.
Should You Pay Off Your Mortgage?
The short answer to that question is yes, you should always plan to pay off your mortgage. The real question is when? Financial advisors report that one of the most common questions that they hear from clients nearing retirement relates to whether or not they should pay off their homes before they retire.
The answer to that that question isn’t always simple. Many people believe that paying off what they owe will give them a sense of relief and security, knowing that their home is paid and they will have a place to live and less debt. However, “feeling better” isn’t always a good reason to pay that particular debt.
As you have probably heard, mortgage debt is often referred to as “good debt.” While you may owe money on your home, as you pay down the mortgage, you gain equity as you pay it off — and it appreciates in value, unlike the “bad debt” like credit cards, which don’t. That’s why most advisors recommend that clients at all phases of life focus on paying down bad debt before tackling the good debt. When considering whether to pay off your home, you need to consider a few other factors:
How much do you have saved for retirement? Most advisors recommend that you should have at least double the value of your home saved for retirement. So, if your home is worth $200,000, you should have at least $400,000 saved to carry you through your retirement years before you consider paying off the mortgage.
What is the real interest rate you’re paying? Bad debt should be tackled first because it’s usually a higher interest rate than your mortgage. However, if you are eligible to deduct mortgage interest on your taxes, your actual interest rate could be lower. If you only have a few years left on your mortgage, it might be better to keep funding a retirement account that earns a much higher interest rate, and just let the mortgage note mature.
Get Ahead Without Sacrificing Retirement
In short, if paying off your mortgage comes at the expense of your retirement account, or paying down other debt, then don’t do it. However, there are ways to pay the debt sooner that won’t affect your savings, and will provide that sense of relief sooner:
- Prepay your mortgage. Making just one extra payment per year over the life of the loan can reduce the loan life by at least five years. Try paying one half of your monthly mortgage payment every two weeks; by the end of the year, you will have made one extra payment.
- Refinance to a shorter term. If you have more than 15 years left on your mortgage, refinancing to a 15-year, or less, mortgage can get it paid off sooner, as long as you can make the larger payments.
- Use investments to pay your mortgage. If possible, try using a portion of your portfolio to make an investment that will bring in enough earnings to cover your mortgage payment for you. By putting your money to work for you, you can focus on paying down other debts or increasing savings.
The most important point to remember is to avoid letting your emotions get the best of you. If you focus on your end goal and make smart, well-informed decisions, you can retire with money in the bank and no more debt.