||Ask Dr. Don
Paying off the mortgage in retirement
Dear Dr. Don,
I am a homeowner whose only mortgage is a 20-year fixed home equity
loan of $110,000 at 6.24 percent. I am one year into the loan, with
19 left to go. I have $250,000 in savings outside of my IRA and a
401(k) plan, so I do have funds to pay off the loan.
The loan interest and property taxes (property tax is $6,000 a year)
are currently my only write-offs at tax time. I would like to know
if it makes sense to keep paying loan interest just to have the write-offs
or should I pay off the home equity loan, lose the write-off and not
pay that 6.24 percent interest for the next 20 years? I'm in a 25-percent
tax bracket, retired on a pension and 53 years old.
Thanks for your advice,
The tax deduction on your mortgage isn't reason enough to hold on
to the mortgage. The mortgage interest deduction lowers the effective
rate on your mortgage from 6.24 percent to 4.68 percent (6.24 percent
x [1 - 0.25]). Being able to use the mortgage interest deduction
on your state and local taxes would further reduce the effective
interest rate on your mortgage.
What kind of after-tax yield are you getting on your $250,000 in
savings? If you're earning 2 percent after-tax on your savings,
and paying an effective 4.68 percent on your mortgage, then paying
off your mortgage gives you an increased return of 2.68 percent.
What I don't like about paying off your mortgage is
the reduced financial flexibility. You'll free up an extra $800
in your monthly budget, but will have reduced your savings by 44
percent. Where's that $800 going to go? If you're planning to funnel
it back into your savings then I'm more amenable to you paying off
your mortgage than if the $800 is going to be spent on travel, wine,
women and song.
If you pay off the mortgage and change your mind later,
you'll have a harder time getting a new loan in retirement than
when you were working. With an expected increase in interest rates
on the horizon you may be able to improve the return on your savings
so it's closer to the effective rate on your mortgage.
Maintaining financial flexibility in your 50s will
help ensure that you continue to have financial options in your
60s and 70s.
-- Posted: June 9, 2004