Nobody Likes Their Mortgage But Paying It Off May Not Be the Smart Plan
While everyone's retirement plan is unique depending on the lifestyle they desire, having sufficient assets and eliminating debt are integral to making that plan a reality. Low housing expenses are important to your plan, but there are tradeoffs to paying down a mortgage before retirement.
"Some people want to be very secure in retirement so paying off their mortgage has significant value," says chartered financial analyst Robert Stammers, director of Investor Education for the CFA Institute. "To other people, they want the tax deduction and they know they'll get at least that return on their retirement investment portfolio to cover those costs."
Your dollar can do only one job, though. Paying off your mortgage may feel good, but that doesn't mean it's right for your financial plan.
"You have to take a broader view and look at the best use of your money that will put you in a better situation in retirement," says Angela DiCastri, director of Retirement Markets at Northwestern Mutual.
Reviewing your budget and knowing your risk tolerance are great first steps. Early in your career, a budget helps determine how much you can save and invest while, as retirement approaches, budgets help you analyze whether you've accumulated enough assets. Finding excess money to put towards financial goals is part of budgeting.
"Most people don't have a good feel on where their money goes, but if you look at your annual credit card, it's usually surprising where you spend money," says DiCastri. "You may be eating out way more than you thought, and you may want to use that money instead on debt reduction."
The budgeting process, which can be painful, helps to reign in expenses and facilitate smart financial tradeoffs. Every extra dollar has an opportunity cost and can be used to either eliminate debt or build a retirement nest egg. Paying off debt feels good, especially if that money isn't invested.
Still, building an asset base requires time and discipline. The goal of investing money is to grow those funds faster than fixed expenses like mortgage payments. But unlike credit cards and most other consumer debt, mortgage interest is tax deductible and today's rates are near record lows. If mortgage interest rates were higher, paying down this debt would make more sense, but with rates at about 4 percent, investing that money could yield a higher rate of return.
"For people who have the risk tolerance, investing that money rather than paying off the mortgage is fine, but think about what would happen if the investments don't pan out and you still have to pay your mortgage," says Craig Brimhall, vice president of Wealth Strategies at Ameriprise Financial.
Debt can create stress. If paying down your mortgage helps you sleep better at night, there are simple budgeting tricks to help accomplish this financial goal. When prepaying a mortgage, be sure your lender allocates these extra funds towards principal rather than future monthly payments. Here are tips to make this goal a reality:
Round-up payments: Increasing monthly payments to the next $100 to $500 helps save on interest and can trim years off the mortgage.
Make an extra payment: There are different ways to add in that extra payment. Dividing the monthly payment by two and making that payment bi-weekly will result in one extra payment each year. For those who prefer paying monthly, instead of paying what's due, calculate a new payment by multiplying the monthly payment by 13 and diving by 12.
Refinance: Depending on interest rates, refinancing from a 30-year mortgage into a shorter 15-year or 20-year mortgage will help you pay your mortgage faster. The monthly payment on a shorter-term loan will be higher, which could become a burden if unemployment occurs.
Lump sum: If your balance is small and there's no interest to deduct, paying off your mortgage in a lump sum is a good idea.
For higher balances, using your nest egg to make a lump sum payment could leave you in a lurch if an emergency occurs and you don't have a line of credit on your home. Paying down a mortgage with retirement funds may trigger taxes and penalties. This option only works when, after making the lump sum payment, you still have enough assets and income to meet your other retirement goals.
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