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Planning for a Mortgage-Free Retirement

05/23/2019 Jerrica Farland

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Whether you want to spend your time on the golf course, traveling the world, or just relaxing with friends and family, most people have one common retirement goal — freedom. One thing that can increase personal feelings of freedom in retirement is a reduction in debt and bills.

The largest debt that most people have is their mortgage, so many incipient retirees want to pay it off before they exit the workforce. If you are wondering how to reach that goal, here are several potential plans to consider, plus loads of detailed advice from top financial experts.

Should I Pay Off My Mortgage Before Retirement?

Similar to most financial decisions, choosing whether to keep or pay off your mortgage in retirement is a choice unique to each person. There is no one-size-fits-all answer, as this decision depends on your specific circumstances. Here are the top four issues you should consider:

  1. What are the terms (interest rate, length, fees and other costs) of your loan?
  2. What other assets (and debts) do you have?
  3. What are your budget needs and goals in retirement?
  4. What is your tolerance for risk in investments?

If you have a significant amount of assets held in low interest, liquid accounts, such as savings accounts or CDs, then using those funds to pay off your mortgage could make good financial sense. The interest rate you are paying on your mortgage is likely much higher than the interest those funds are earning and you typically have access to these funds (CD annually) without paying a penalty.

If your assets are in investments that may earn more than your mortgage interest rate, you may gain more by leaving them there. However, having those funds invested in the market does come with some risk — and you may not want to engage with risk when you are near or in retirement.

Aside from the financial considerations, paying off a mortgage also gives many people a sense of security. Eliminating that loan, and the associated stress, can give some people the invaluable feelings of freedom and control. In addition, in most states, home equity is protected from lawsuits and other legal proceedings, and a home being owned outright can make it easier for spouses and heirs to inherit the full value of your property.

What is the Right Choice for Your Retirement?

Even with all of the valuable advantages listed above, paying off your mortgage could come with a few possible disadvantages. Depending on your unique financial situation, these may be important to consider. Randy Kurtz, the Chief Investment Officer with Betavisor, has been profiled in Forbes, The New York Times, and The Wall Street Journal. Kurtz offers three considerations as the main reasons people choose to not enter retirement completely mortgage-free.

  1. The mortgage interest deduction is often the largest available. We like tax deductions!
  2. The after-tax interest rate on your mortgage [can end up] making the mortgage [rate very low]. Paying off that debt means locking in that same very low rate as an investment return. [Frequently], investors can earn more from their investments over time.
  3. Most importantly: liquidity, liquidity liquidity! Retirees often need liquidity. If a retiree has $1,000,000 in assets and a $200,000 mortgage, [once] they pay off that mortgage, they will only have $800,000 [in liquid assets]. Many retirees [benefit from taking] money out of their house, and are not well served by putting more money into their house. The equity in your home earns you an exact rate of 0% over time. You get the home’s appreciation without owning all of the equity. Many retirees are better off paying the minimum mortgage payment each month, and maximizing their liquidity.

So, for certain people in specific financial situations, it can indeed be beneficial to carry a mortgage well into retirement. But for a lot people, the benefits of golden years unburdened by housing concerns outweighs many of those monetary considerations.

How to Plan for a Mortgage-Free Retirement

You’ve decided to explore a mortgage-free retirement. Now, how do you get there? Here are plans, strategies, and other strategic advice from financial experts and industry insiders on the best means of achieving that goal.

Daniel Grote is a Certified Financial Planner, Behavioral Financial Advisor, Partner
with Latitude Financial Group, and possesses over 17 years of experience in the financial planning profession. Grote advises that his clients should focus on paying off their mortgage after clearing a few other financial hurdles. He offers this step-by-step advice:

  1. First, fully fund an emergency fund with three to six months of your non-discretionary fixed expenses.
  2. Next, pay off all non-mortgage debt.
  3. Direct 15% of your household income to tax favored retirement plans such as Roth IRAs, 401(k)s, and SEP IRAs [Simplified Employee Pension Individual Retirement Account].
  4. Finally, fund a 529 college savings [account] when children are involved.

Once those tasks are complete, you can direct any extra funds toward paying off your mortgage. Overall, it’s a statement of the obvious to say that retirees who don’t have a mortgage live more comfortable, stress-free retirements.

One of the biggest challenges tax pros have given for maintaining a mortgage rather than paying it off is the loss of the mortgage interest deduction. However, as a below-the-line deduction, it has become less likely to be beneficial with the tax law changes enacted at the end of 2017, which substantially increased the standard deduction and sharply reducing the number of people who benefit by itemizing on their returns.

Get deeper expert perspectives on the 2017 tax bill and its implications in our Guide to Homeowner Tax Deductions.

Wes Moss is the Chief Investment Strategist at Capital Investment Advisors, the best-selling author of You Can Retire Sooner Than You Think, and was named a Barron's top 100 financial advisor in 2017. He agrees that a lack of mortgage debt can lead to an increase in satisfaction for most retirees.

There’s a distinct difference between happy and unhappy retirees when it comes to the years left they have to pay on a mortgage... According to the research for my book, there is a tremendous psychological benefit to paying off a mortgage. Even if [retirees] have a lower interest rate, [they experience] tremendous peace of mind having paid off their major debt prior to stopping work.

One way to get rid of a mortgage would be to accelerate payments on a monthly basis. On average a $300,000 mortgage can be reduced by nearly a decade by adding $300 a month extra towards principal.

Another rule of thumb to remember when thinking about paying off that mortgage is the “rule of thirds.” If you were able to pay off the rest of your mortgage with a third or less of your after-tax investments (that does not include retirement accounts), then you should pay off the rest of the mortgage. It would still leave you ample liquidity heading into retirement.

If you’ve decided you want to go into retirement without your mortgage, the next step is to figure out where the requisite funds will come from. Let’s examine some options and plans.

Refinance to a Shorter Mortgage Term

Another strategy that can get you closer to paying off your mortgage (both in retirement and before) is to refinance your loan. David Reiss is a Professor of Law at Brooklyn Law School, where he is the Research Director for the Center for Urban Business Entrepreneurship. He advises homeowners to consider refinancing well before retirement. 

It is always good to reduce your expenses when you enter retirement. Paying off your mortgage in advance of your retirement is a great way to permanently reduce your expenses at the same time that your income is going down.

Many people refinance their mortgage from time to time and that extends the life of their mortgage debt thirty years from the date of the refinance. Homeowners in their forties and fifties should consider refinancing into a 15-year fixed rate mortgage if they can afford the higher monthly payment. This can line up the last mortgage payment with their retirement target date.

If a homeowner can’t refinance into a 15-year mortgage, they can make extra payments on their 30-year mortgage when they can. If these prepayments start early in the life of the mortgage, they can have a real impact on reducing the life of the mortgage.

Want to know more? Learn about various refinancing options to see what’s right for you!

Should I Pay off My Mortgage with My 401(k)?

One of the largest assets that most people have in retirement is a 401(k) or other individual retirement account (IRA). It’s possible to use these funds to pay off your mortgage, but should you?

Most financial advice warns against withdrawing money from a retirement plan due to the fact that you will be subject to penalties before age 59½. You will also have to pay taxes on your retirement plan withdrawals (at any age), and a large distribution (such as a withdrawal to pay off a mortgage) could push you into a higher tax bracket in the year that it is taken.

Even with the tax issues mentioned above, pulling from your 401(k) to pay off your mortgage might be a good strategy for many. The biggest advantages to using this strategy include eliminating your monthly mortgage payments and loan interest expenses, as well as developing stronger asset protection. Over the course of a conventional 30-year mortgage with a 5% interest rate on a $200,000 home, the total interest costs paid are almost as much as the home valued at $186,000!

For many retirement-age individuals with known expenses, goals, and plans, a large distribution from a retirement plan may not need to be replenished. In addition, the extra room in your monthly budget due to not having a mortgage payment may be useful for other expenses that come up during retirement, such as medical or other care costs.

Could a Move Help You Retire Mortgage-Free?

One other option that homeowners should consider is downsizing in order to greatly reduce or even eliminate mortgage debt. Using the profits from a larger home sale can help you buy a new home outright — starting your retirement with a clean (and debt-free) slate.

Sarah Mueller founded and authors the blog Early Bird Mom, which offers guidance on decluttering and organizing, and runs the Facebook communities, “Decluttering Club” and “Declutter My Home.” Here is her advice for a smooth transition to an organized and debt-free retirement.

My advice is to downsize and declutter as soon as possible when preparing for retirement. This will allow you to enjoy a smaller home — you'll have lower payments while you do have a mortgage [or no payment at all], and the upkeep and maintenance will be much easier too.

If you have a storage unit, empty it out ASAP, so you can put that money toward other financial needs. Retiring without a mortgage will give you much more flexibility to travel and enjoy other hobbies without the burden of a large monthly payment.

The Help You Need to Make Your Retirement Dreams Come True

If a mortgage-free retirement is one of your dreams, there are many ways that you can make it a reality. Small steps that you can take today will lead to big progress as long as you take the time to evaluate your financial options and make a plan that works for you. If your retirement goals include updating your mortgage options, you can start exploring different avenues now with our easy quote tool.

Have questions? Contact a PennyMac Loan Officer. We will happily walk you through all of your options so you can make the most informed decision possible. Already have a plan to downsize before retirement? Get pre-approved now.

The views, information, or opinions expressed in this blog do not necessarily represent those of PennyMac Loan Services, LLC and its employees. The inclusion of links to third party sites is not intended to assign importance to those sites or to the information contained therein, nor is it intended to endorse, recommend, or favor any views expressed, or commercial products or services offered on these third party sites, or the vendors sponsoring the sites.