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Retiring free and clear of mortgage debt

By Barbara Whelehan · Bankrate.com
Friday, April 30, 2010
Posted: 10 am ET

Should you continue to make mortgage payments after you retire? Or should you pay off the house before quitting your job for good?

Financial experts are divided on this issue.

Reasons you may not pay it off

Bankrate's own Dr. Don says it makes sense to compare the after-tax return on investments against the mortgage rate. "If you can earn more after-tax on your investments than the effective (after-tax) rate on your mortgage, you're better off investing," he says. 

But if, for example, your mortgage rate is 4.6 percent and you're earning 3.1 percent on your investments after taxes, you're better off paying down the mortgage, Dr. Don says.

Certified Financial Planner Bill Losey writes in his Retirement Intelligence newsletter that "while owning a home free and clear may seem like the obvious best scenario, there are valid reasons not to pay off your mortgage." A couple reasons he offers:

  1. You'd lose a valuable tax break in the mortgage interest deduction.
  2. If you bought your home 20 years ago and it appreciated a lot since then, inflation will have eroded the impact of a house payment to your pocketbook. "Think of it this way: If 20 years ago you bought your house for $200,000 and today it is valued at $500,000, then today it's as if you're paying 40 cents on the dollar," he says.

Reasons you should pay it off

Other experts say it's a no-brainer to pay off your mortgage early. Roy Williams, CEO of Prestige Wealth Management Group in Flemington, N.J., says paying off the mortgage is "very important. Retirees are more vulnerable to volatility in the market. If individuals enter retirement mortgage-free, there is much less pressure on the portfolio during potentially volatile times."

The fewer demands placed on your portfolio, the more time it has to recover from market malaise.

But you should only use after-tax money to pay it off, Williams warns. It seldom makes sense to use tax-deferred money from a traditional IRA, 401(k) or 403(b) to pay off your mortgage -- "unless you are still able to maintain a low tax bracket" -- meaning 15 percent, he says.

Suze Orman is a big proponent of paying off the mortgage -- especially for women. She even advocates allocating less money to a retirement account and more toward the mortgage to ensure it's paid off early.

In an interview with Bankrate a couple years ago, she used the example of a $200,000 mortgage with a 30-year term and a $1,200 payment. If you retire at age 65 with a $100,000 mortgage balance and 10 years left on the term, you'd need a portfolio worth $400,000 earning 5 percent annually to make the payment, she says. 

"Don't you think it's easier to pay off that $100,000 that you owe rather than to have to save $400,000 just to generate the income needed to pay that amount off every month for 10 more years?" she asks. "Your mortgage, after all, was only $200,000 to begin with. Yet there are plenty of financial advisers and accountants who will say to you, "Oh, please ... the money is cheap and you get a great tax write-off. Just keep doing it and don't worry about it."

You may need your equity

If ever there's a good reason to get that mortgage yoke off from around your neck, it's the flexibility you gain by doing so. A recent report published by the Center for Retirement Research at Boston College focuses on the importance of home equity on retirement security.

Home equity can be tapped via a reverse mortgage "as Social Security replaces a smaller share of pre-retirement incomes and people rely increasingly on meager 401(k) balances rather than on traditional pensions," according to the report.

"Households should be cautious about tapping their equity before retirement so that it is preserved for retirement needs."

And the reverse mortgage industry needs to get into gear by offering better products, according to the report.

"Financial services firms need to acknowledge that existing reverse mortgages are often complicated and expensive and that the industry needs to develop innovative approaches to ensure that retirees have easy and efficient access to their equity," the report concludes.

My take on this: Paying off the mortgage will help ensure that your retirement is built on a solid foundation rather than on quicksand.

What do you think?

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1 Comment
Craig
May 02, 2010 at 9:40 pm

I think it all depends upon cash flow and tax rates. Yes ideally, paying off the mortgage reduces outflow of cash and provides a peace of mind. However, carrying a small reduced mortgage at low interest rates may provide some tax write offs if you are in a higher income bracket.