Planning for Retirement: When Should You Pay Off a Mortgage Early?

I have most of my working years in front of me, but thinking ahead in life, it sounds extremely appealing to pay off my mortgage and drop that monthly payment. Just the thought of going into retirement with no or minimal debts gets me excited. Is paying off your mortgage before you retire right for everyone? The short answer is no. Here is why.

WHEN TO PAY OFF YOUR MORTGAGE EARLY

If you’re trying to live off limited or no income—as most heading into retirement hope to—paying off your mortgage early can take a big chunk out of your monthly expenses. Not to mention the mental lift that you get not having to worry about that expense!

You might also want to pay off your mortgage early to save on interest payments and servicing fees. While you won’t be able to deduct the interest on your taxes anymore, you’ll likely still save money. You might not want to do this if it would cut into retirement funds that may continue to appreciate over time. Note that if you withdraw funds from your 401(k) before age 59.5 to pay off your mortgage, you’ll end up paying a 10% penalty on top of your standard income tax. It’s unlikely that the savings from getting rid of your mortgage will be greater than the penalty you pay for withdrawing funds early.

If your mortgage rate is higher than that of risk-free returns, paying off your mortgage can be as impactful as earning a risk-free return the equivalent of your interest rate. For example, if you are currently paying an interest rate of 5%, paying off your mortgage (and saving on interest) is like getting  tax-free 5% return! Like with most things in personal finance, it is all about finding a balance between the cost of a loan and the returns you might get with your funds stored elsewhere.

It may also make sense to pay off your mortgage if you do not have any high-interest debt, such as credit card debt. Since it is usually a good idea to focus on paying off your high-interest debt while still making payments on your low-interest debt, paying off your mortgage before your high-interest debt is typically a bad idea.

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WHEN NOT TO PAY OFF YOUR MORTGAGE EARLY

If you are behind in your retirement savings, saving in your retirement accounts should likely be your top priority. For example, funds that grow in your 401(k) aren’t taxed until you withdraw the money. If you aren’t sure if you are behind on your savings, find a local financial advisor to help you make a retirement plan.

How much liquid cash do you have saved outside of your investments and home? If it’s not much, it might not be the best idea to pay off your mortgage and become “house rich and cash poor.” It is always a good idea to have an emergency fund with enough cash available to cover the next three to six months of expenses. When in retirement, it’s usually a good idea to have even more than that set aside in cash. How much depends on your retirement income and any risk with your retirement funds. Plus, if you pay off your mortgage early and down the road find you need the money, it may be harder to tap into the equity of your home later.

Having a diverse set of investments and assets is a good idea, so if paying off your mortgage puts most of your money into your house, it may not be the right thing for you. Speaking with a financial advisor can help you figure out if you’re too deep into one asset type or another.

Deciding if you should pay off your mortgage early is a decision filled with variables unique to you. If you aren’t quite sure if you’re ready to do it yet, see if you can responsibly do two to three extra principal payments every year. These payments can chip away at the sum, saving you money long-term.

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About Oliver Ames

Oliver is VSECU's social media strategist and spends most of his day engaging with members through our Facebook, LinkedIn, Twitter, and Instagram profiles. He has a background in science education, non-profit fundraising, business communication, media production, and membership-based organizations. When not at work, Oliver spends much of his time with his wife and son at their home in Montpelier.

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