Should You Pay Off Your Mortgage Before You Retire?

by Emily Brandon

Financial planner Nancy Langdon Jones of Claremont, Calif., likes the idea of having her home paid off before she retires. Her husband, actor Claude Earl Jones, would rather have the money invested than tied up in the house. "For my husband, it was very important that he could look at his brokerage statement and see that the money was there," she says. "I wanted to know that if something came up we wouldn't have to worry about the house payments."

After sitting down with a financial planner to get a neutral, third-party view, the Joneses found their compromise: downsizing to a smaller house (with a more manageable mortgage payment) while keeping most of their savings in their brokerage account.

Their struggle illustrates a divide in the financial planning industry. Should you own your home free and clear before you retire? Or is it better to keep your mortgage and invest the money elsewhere at perhaps a higher return while reaping the mortgage-interest tax break? Here are factors to weigh when deciding which path is right for you.

Compare interest rates. The typical 30-year, fixed-rate mortgage interest rate is currently 6.57 percent, according to the Mortgage Bankers Association. If you are getting a higher average rate of return on your investments elsewhere than your interest rate, it makes sense to keep your mortgage. Just over half of affluent baby boomers born in 1948 who have both mortgages and investable assets of at least $1 million do not plan to pay off their mortgages until their 70s, if ever, according to a recent survey of 500 people by investment management firm Bell Investment Advisors.

"Mortgages help free up funds that otherwise would be tied up in property ownership for investment in equities," says Jim Bell, the firm's founder and president. Investing in the stock market money that would otherwise be tied up in home equity also gives you the option of raising cash to deal with unexpected expenses like medical bills or even rising gas prices.

Pay it down. If you're not sure whether you can achieve a higher return in the stock market or aren't willing to take the risk, then you should prepay your mortgage principal as you approach retirement. "We don't know what the earnings are going to be in the market," says Vern Hayden, a certified financial planner and president of Hayden Financial Group in Westport, Conn. "The guaranteed return on your money is the interest you were paying" on the mortgage.

Refinancing from a variable-rate loan to a fixed-rate mortgage can give you a better idea of what your payments will be in retirement. Brent Neiser, a certified financial planner and a director of the National Endowment for Financial Education, recommends paying down principal above your monthly payments when you can. "Adding money at your discretion gives you the ability to stop that when times are tighter," he says. On a $150,000, 30-year mortgage at 6 percent interest, paying just $100 extra per month would save you $45,000 and allow you to pay off the debt seven years sooner than following the normal payment schedule.

Don't rob your retirement plan. According to the most recent Federal Reserve Survey of Consumer Finances, 32 percent of households headed by someone age 65 to 74 were carrying home-mortgage debt in 2004. It can be tempting to dip into your 401(k) or IRA to pay it off. But mortgages shouldn't be paid off in the absence of other savings. "You need to have a balanced approach of keeping that retirement savings robust and also have regular savings for emergencies so you don't turn to the credit cards if your refrigerator or furnace breaks down," Neiser says. Also, pay off higher-interest debt like credit cards and car loans before your mortgage. "If you have your money tied up in a paid-off mortgage, in order to access that equity which is in your house, you have to go pay the bank to get your money [by refinancing the loan]," says Elisabeth Plax, a Beachwood, Ohio, financial planner and wealth manager for Plax & Associates Financial Services. "If you invest it, all you have to do is liquidate it" by selling.

Consider tax breaks. The interest you pay on your home mortgage is tax deductible on up to $1 million in debt. You can also typically write off interest on up to $100,000 of home-equity debt. But you benefit from this tax perk only if all your itemized tax deductions, including your mortgage interest, add up to more than the standard deduction that almost everyone gets automatically. For 2008, the standard deduction amounts are $5,450 for singles, $10,900 for couples, and $8,000 for heads of households.

Jonathan Pond, a financial planner and author of Grow Your Money! 101 Easy Tips to Plan, Save, and Invest, argues that you need to be in the 35 percent tax bracket, or make at least $350,000 annually, for the tax break to be worthwhile. Most Americans in the 25 percent tax bracket might pay, say, $10,000 in mortgage interest but save only $2,500 in taxes.

Look at the emotional aspect. Some 16 percent of workers and 10 percent of retirees think making mortgage payments or paying for a house is the most pressing financial issue facing Americans today, according to an Employee Benefit Research Institute survey done this year. But knowing that you own your home can give you a sense of stability in retirement--security that the possibility of stock market gains will never be able to. "Paying off the mortgage is going to reduce their need for cash flow when they go into retirement," Hayden says. "I just think people ought to get out of debt because times are so uncertain, and the less they are shackled, the better they are going to be able to deal with whatever their problems are going to be."