House Rich & Cash Poor – Paying Off Your Mortgage

August 31st, 2020 by Jim Allen

As you near retirement, there are many things to worry about: running out of money, rising health care costs and nursing home care for example. Another big concern is “where do I live during retirement?” According to an AARP study, most people have a strong desire to remain in their current home for as long as possible. While “aging in place” may be desired, selling and downsizing also has benefits. This decision requires careful thought and analysis to determine which approach is best for you.

If we assume that you will start retirement in your current home, then paying off your mortgage is the next thing to think about. With previous generations it was expected to have your home paid for by retirement. But about half of retirees today have a mortgage meaning it isn’t as clear cut as in the past. So, a question is “should you pay off your mortgage prior to or at retirement?” There are a couple of approaches to consider when thinking about this question. One approach is to consider the emotional aspects of having a paid for home, and the other is to look at the decision from a strictly financial aspect. So, let’s look at these two approaches.

The Debt Free Approach
As just mentioned, it was almost unthinkable for previous generations to not have their home paid for by the time they retired. However, Baby Boomers typically didn’t have this same mind set as they were accumulating their retirement nest egg. Now nearing retirement and having just lived through one of the worst economic downturns in recent history, their risk tolerance has changed. Having that confidence that your home is paid for and you won’t have to worry about losing the home during retirement is resonating with pre-retirees. So from an emotional standpoint, having a home that is paid for is now becoming a priority. The issue, of course, is how to pay off the mortgage.

Ideally, paying down the mortgage during pre-retirement was incorporated as part the financial plan. If not, then we have to look at the funds available and the tax cost of using them when deciding if we can or should pay off the mortgage. While some may like the peace of mind of having the home paid for, others may not want to use up liquid assets to make a large payment on the mortgage. This may make you feel “house rich and cash poor”, so dealing with the emotional aspects of this decision is a very individual thing.

The Financial Sense Approach
As discussed, paying down the mortgage can be an emotional issue, but maybe not for everyone. Some will just want to know if paying down the mortgage is the best use of their money. One way to view paying off the mortgage is that the interest cost that is eliminated can be looked at as earning that rate of return on the money used to pay the mortgage. For example, if your mortgage interest is 4%, you are saving 4% on the funds used to pay down the mortgage. However, mortgage interest may provide some tax benefits that must be taken into account. If you have a mortgage interest rate of 4% but you are in a 25% tax bracket, after the loss of the tax benefits, you are really saving 3%. One other piece to this equation is the tax consequence on the funds used to pay down the mortgage. For instance, if the money has to come from an IRA, then the tax and possible penalty on the IRA distribution makes this less attractive. Using this approach, we can analyze whether it makes financial sense to pay down the mortgage. This decision is an important part of cash flow planning in retirement.

Whether to pay down the mortgage prior to or at retirement is a complicated decision. Of course, it isn’t an all or nothing strategy either. You can make additional principal payments and accelerate the payoff of the mortgage over time, or even use a reverse mortgage to stop payments and increase cash flow but still have the debt on the home. There are many options available and we look at all the tools in the toolbox to help you make the choice that is right for your individual situation.

Let us help you navigate this difficult decision as part of your retirement planning.