Pros and Cons of Paying Off a Mortgage Before Retirement

Set of retirement rocking chairs on a porch of a home with a mortgage

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If you have the means to pay off your mortgage early but choose not to do so, you are in effect choosing to invest with borrowed money. That would make sense if the rate of return on your assets exceeds the interest cost of your mortgage after taking into account risk and taxes. For most people, that is not the case.

Key Takeaways

  • If you're thinking about paying off your mortgage before retiring, compare the pros and cons of each option.
  • One of the pros of paying off your mortgage is that it is a guaranteed, risk-free return.
  • One of the cons of paying off your mortgage is reduced liquidity, as it is much easier to access funds sitting in an investment or bank account.
  • A study by the Center for Retirement Research concluded that "all except [a] small minority will be better off paying off their mortgage.”

Pros to Paying Off Your Mortgage

One of the pros of paying off your mortgage is that it is a sure way to get a risk-free return. You can invest in safe, risk-free assets like certificates of deposit or Treasurys. However, you'll rarely earn a higher return on those investments than the interest rate you pay on your mortgage.

You might be willing to take risks and approach investing with a long-term view. For that to work, you would need to invest your money in stocks (stock index funds are best to start with) to have the best chance of earning a return that exceeds the cost of your mortgage.

The main risk is mismanagement of investments on your part. For example, many investors earn below-average returns, because they make emotional, not rational, investing decisions.

Keep in mind that debt is a bet on your future ability to pay the money back. While most people are fine with taking risks, there's more to think about than the interest rate alone. If life events were to leave you in a place where you couldn't pay your mortgage, where would you go? If you're not able to work to produce income, you have few options. Paying off your mortgage before you retire is the least risky option for most people.

Cons to Paying Off the Mortgage

The biggest downside to paying off a mortgage early is reduced liquidity. It is much easier to access funds sitting in an investment account or bank account than to access funds in the form of home equity. Once your home loan is paid off, consider opening a home equity line of credit, so you have liquidity or can access the equity in your home if you need to.

Study Finds Most Should Pay Off Their Mortgage

The Center for Retirement Research at Boston College conducted a study of retirees, incomes, and mortgages. It concluded that in retired households, paying off a mortgage is better for all but a few people.

The small percentage of people for whom they found that not paying off a home loan was best were willing to invest an amount in stocks equal to or more than the amount they borrowed for their mortgage. This study looked at both risk and taxes and found that for most retired people, paying off their mortgage is the best option if they have the means to do so.

What Assets Should You Use to Pay Off Your Mortgage?

If you are retired and want to pay off your mortgage early, how do you go about liquidating assets to do so?

First, convert risk-free investments into taxable accounts. Why? You are trading one risk-free asset for another; your savings account for a home with no loan, for example.

Second, convert low-risk investments into taxable accounts for the sake of investments that can earn higher returns. You'd be trading them in for a home you would own free and clear. That would free up income that you could place into other assets or save.

Before using your assets to pay off your mortgage early, you may want to account for the impact that taxes will have on your withdrawals and mortgage.

Third, if you are over age 59 1/2, you could think about withdrawing from tax-deferred accounts. You could use them to pay off a portion of your mortgage.

Note that withdrawals from tax-deferred accounts are included in your taxable income in the year you make the withdrawal. If you take a large chunk of money out of an IRA or 401(k), the extra income could bump you into a higher tax bracket. You can avoid that consequence by breaking up large withdrawals into smaller increments to be withdrawn over several years.

The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.