I recently taught a retirement planning seminar to 17 wonderful people that were within 5-10 years of retirement. A common question people were asking during our breaks was whether they should pay off their mortgage before retirement. I gave a consistent answer that no one seemed pleased with, “it depends.” And it’s true. So often, people want a black and white answer; however, everyone is different when it comes to this question.
Anytime someone gives you an answer without understanding your full financial background, you should be skeptical.
I can sympathize with wanting to get rid of the largest monthly payment on your balance sheet, but it may not make the most financial sense. Here are some things to consider when deciding if you should get rid of that monthly payment.
1. How long have you had the loan?
The longer you have had your loan, the less interest you are currently paying. If you are nearing maturity of your mortgage, you may be paying very little towards interest. It may not make sense to pay off your mortgage if all you are doing is reducing your principal. On the contrary, if you recently purchased or refinanced your home, most of your monthly payment is likely being paid toward interest. It may be beneficial to pay off your mortgage to save on interest charges. A key to understanding how much interest you are currently paying is understanding your mortgage rate.
2. What is your mortgage rate?
It is important to consider the rate of return on all your investments. Your mortgage rate is no different. If you have a high mortgage rate, it may be more beneficial to pay off your mortgage. If you were able to lock in during some of the recently historic low interest rates, it may be less desirable to pay off your mortgage. All that being said, it is important to understand your mortgage rate in context with all of your other investments to determine which place to put more of your money.
3. What kind of return are you getting in the market on your other investments?
The return you are getting on your investments should be directly tied to your comfort with market fluctuations. The more comfortable you are with high the ups and downs of the market, the more risk you could be taking on in your portfolio – which should lend itself to a higher expected return over the long-term. Ultimately, you want to consider the opportunity cost of not putting your money in your other investments like a 401(k), IRA, or brokerage account. If you are getting a higher rate of return in your other investments, it may make sense to put additional savings into the market rather than pay off your mortgage.
4. Do you have higher interest debt payments?
You should consider your mortgage rate compared to your investments and your debt accounts. For example, if you are paying 18% on a credit card than it would make sense to spend additional savings or cash on higher outstanding interest rates – assuming your mortgage rate is lower than 18%. You should compare your mortgage rate with all outstanding debt (home equity, car, credit card, personal loans, etc.) prior to deciding which account to pay off first.
5. Do you need the cash?
Another consideration is whether you need the cash for a future purchase or emergency fund. Financial experts often recommend having 3-6 months, depending on your career field, in emergency savings. Using cash to pay off a mortgage makes it difficult to tap into the cash reserves should an emergency arise.
Ultimately, the decision is yours. My goal is to arm you with the tools needed to make a logical decision. Use the math to make a sound judgement on whether you should pay off your mortgage prior to retirement.
Need an example?
Bob and Karen:
Retirement Age: 60
Home: Purchased 1 Jan 1998
Mortgage: 30-year fixed 4.5%
Time remaining: 10 years
Price Paid: $200,000
Money down: $0
Current Estimated Value: $300,000
Current Date: 1 Jan 2018
Investment Rate of Return: 6%
Cash on Hand: $100,000 from inheritance
Question: Should Bob and Karen use the recently inherited $100,000 to pay off their mortgage or invest it in their retirement account?
The decision for Bob and Karen depends on many variables and assumptions. Hopefully, this example provides a sample of an analysis you could conduct on your own to determine if paying off your mortgage is beneficial given your circumstances. If it seems like too much math or you still have questions, please visit us at www.boltfinancialgroup.com
Do you have a question on paying off your mortgage? We would love to help. Contact us at (614) 635-0102 or visit us a www.boltfinancialgroup.com
This example in no way is meant to provide a solution for your retirement or mortgage decision. This is merely an example of how an analysis could be conducted. There are many different scenarios that could change whether you should or should not pay off your mortgage. The purpose of this exercise is to illustrate some of the things you should consider before making your decision. Ultimately, we recommend sitting down with a financial advisor prior to making any decisions.