In the past many advisors consistently recommended retirees do all they can to have a “debt-free” home. In many instances, this required that any mortgage associated with one’s primary residence during retirement be paid off from existing accumulated savings.
The justification for doing this was most often the desire to gain a sense of security in knowing that the total value of this important financial cornerstone was totally owned and paid for without future worry or consideration for any further monthly mortgage payments.
Today however, it is not uncommon for retirees to continue their mortgage debt into and during retirement. Studies, such as the Federal Reserve Survey of Consumer Finances, have determined that approximately one-third of retirees through age 75 are now carrying home mortgage debt and one-fifth will continue holding mortgage debt beyond that age. In all, 25% of home owners who consider themselves retired also have a continuing home mortgage.
So, the question naturally arises whether continuing a mortgage during retirement is a good or bad thing to do, and whether there are any circumstances present that would make it a desirable, or undesirable debt to retain.
Potential Reasons for Keeping a Mortgage:
· The mortgage interest deduction may reduce your federal income tax liability. This is obviously beneficial, but usually not to a significant degree unless you live in an expensive area and own a relatively high-priced home. For most homeowners, the amount of interest and taxes that are paid on a median-priced home does not provide a very significant tax benefit. In fact, there may be no tax benefit at all. For example, someone in a 25% tax bracket with just 20% equity in their home is likely to have no tax benefit, because taking the standard deduction instead of itemizing deductible expenses will often exceed the value of the mortgage interest tax deductions. Also, if one has a relatively low interest rate loan, (below 5.0%) the interest deduction will usually not add up to very much in producing tax savings. It is usually only homeowners with relatively high-priced homes and higher tax brackets who will find the interest deduction to be large enough to become more effective in reducing personal income taxes.
· It makes sense to keep a mortgage if it will keep funds invested that are expected to earn a higher rate of return than the interest costs of your mortgage. This enables one to use another’s monies (the lending institution’s) at a lower cost than using one’s own savings. The objective is to gain more investment return over the life of the mortgage than the total accrued interest that is paid during its term. Another way of doing this that will eliminate paying the ongoing mortgage payment from your current income is to make the regular monthly payments from scheduled matching savings withdrawals instead of making one total payoff payment. This will cover the monthly cashflow expense and enable the balance of your savings to earn investment returns. Caveat: For this approach to result in financial gain over time, it is necessary for the interest rate on the mortgage debt to be attractive. In other words, the interest rate must be relatively low in comparison to net historical investment returns. If your interest rate is below 5.0%, it does not make sense to pay off a mortgage early if your investment funds are likely to earn a return that compensates you for the year-to-year variability of future market returns.
· Keeping a mortgage is usually a good idea if it enables you to continue contributing to retirement savings. If you can continue making maximum permitted retirement contributions annually, and still have enough income left over to accelerate monthly mortgage payments, it may be a reasonable to do. But, it is always a bad strategy to withdraw any existing taxable retirement savings to pay off a mortgage, since those withdrawals will be 100% taxable in your highest marginal tax-bracket. The basic question is whether any extra money should be directed to additional retirement savings or to mortgage payments. Many households that are currently accelerating their monthly mortgage payments are making the wrong choice if they have not yet contributed the maximum yearly amount of retirement savings permitted. Whether it is a 401(k), IRA, or other type plan, you will almost always be better off adding those dollars to your sheltered savings. If you participate in a retirement plan that provides a matching employer contribution, the immediate return benefit of getting as much money matched as possible will provide greater immediate and future long-term value.
Potential Reasons for Paying Off a Mortgage:
· It may reduce or eliminate income taxes on future social security payments. Social security benefits become taxable for married couples filing jointly when ½ of social security received plus other income is more than $32,000 ($25,000 for single filers). This enables many moderate-income retirees (who have modest income needs) to receive social security benefits while withdrawing additional taxable retirement savings to cover total yearly income needs with little or no income tax liability. In many parts of the U.S. the level of income that can be taken without tax liability will provide a reasonable income to live on when mortgage costs are eliminated. As a result, mortgage debt payoff becomes desirable, because it may substantially reduce or eliminate the income tax liability that will be triggered if a higher level of taxable savings is needed and withdrawn to cover a continuing monthly mortgage expense. The extra income can cause some to pay more in taxes on social security income as well as on other savings withdrawals and may cause some of the income to be taxed at a higher tax-bracket level.
· For retirees who may have inadequate savings to fully fund future retirement expenses, it may make a reverse home mortgage available to you should you have this need. A reverse mortgage can be an additional financial resource to pay for future living expenses if your retirement savings run low or are fully depleted. The additional liquid capital that a reverse mortgage makes available can be thought of as “insurance monies” for those who may use all other retirement savings during retirement. To accomplish a reverse mortgage, it is necessary to have no existing mortgage debt on your home. If you do, you can use some of the lumpsum mortgage advance to pay it off when signing the closing documents. This arrangement can provide options for a lump sum, credit line, and/or monthly amount of money to be deposited to your savings to increase the amount of cash you have for future living expenses.
· It may be best to pay off your mortgage if an heir wants to inherit your home. This may be best to do if a child or other relative, who wants to be the future owner of your home, does not have the financial resources to obtain and make future mortgage payments while living there. This will help keep the house for your heir’s use and hopefully also keep a future forced sale form occurring.
· In many states, it is beneficial to own a home without a mortgage when involved in a lawsuit. In these states, your home is exempt from a judgement if it is owned outright and provides additional protection from being taken in bankruptcy proceedings.
· Paying off your mortgage may provide an intangible psychological benefit. Some will find that having no mortgage will enhance their peace of mind and enjoyment of activities when spending monies during this time of life. The psychological benefits may be more important for some than other financial considerations.
These are some of the considerations in making this important decision. There are others as well. If one is in the financial position that enables a mortgage payoff at any desired time in the future, the decision about paying off a mortgage need not be a rushed one, since it can be acted upon at any future time when conditions make it desirable. Two examples of changing conditions that could trigger the desire to pay off one’s mortgage are (1) higher interest rates incurred on an existing adjustable rate mortgage and (2) lower investment returns that may be expected during times when the economy is contracting. Often the existing external and personal considerations require a more careful analysis. At these times, it can be helpful to discuss this important decision with a qualified financial advisor whom you trust.
Greg Tinaglia
Last Updated: 06/23/2017