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retirement

Planning for Retirement: Should You Pay Off the House Early?

The new tax law adds wrinkles for homeowners deciding whether or not to retire without a mortgage.

Colette Leavitt faced a difficult financial decision a few years ago, as she approached her sixties. She originally planned to retire early, at age 62, with her mortgage paid off. She would be free and clear of the financial burden of monthly payments. “It would open up some income to do things for enjoyment, as opposed to obligation,” says Leavitt, of Hooksett, N.H.

But in the end, Leavitt, now age 60, decided to keep her loan. She owes just $49,000, at a rock-bottom 3.25% interest rate. Despite the low balance, she felt the peace of mind of building up her savings and keeping cash in hand for future expenses outweighed her initial desire to be mortgage-free.

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Although she worked with her longtime financial planner, Peter Canniff, who is with Advanced Portfolio Design, in Westford, Mass., it was still a hard choice to make. Dealing with mortgage debt isn’t always just about the finances. The decision is often emotional. “You think about it, think about it, and think about it,” says Leavitt, an administrative assistant at a utility company. “It can cause a lot of anxiety.”

These days, more retirees are carrying mortgage debt into retirement. About half of all retirees ages 65 to 69 were mortgage-free in 2015, down from nearly 60% in 2000, according to mortgage giant Fannie Mae. But you’ll need to carefully consider whether carrying a mortgage into retirement is right for you.

You may be in a position similar to Leavitt’s, wondering whether to pay off your mortgage, particularly if you are a few years away from the payoff date and have the balance whittled down. Should you pursue the relief of having no monthly payment hanging over your head anymore, or find other uses for your money that could potentially be more beneficial to your bottom line?

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You can start to answer that question by considering a variety of factors, such as whether you plan to stay in your house, your cash flow needs in retirement and how much investment risk you can tolerate.

Your feelings about debt and financial security could affect the decision you make. Investing in stocks may deliver a higher return than paying off a mortgage with a low interest rate—but you may not be able to sleep at night. And changes under tax reform also may affect your choice.

Will You Itemize Your Taxes or Not?

Under the new law, the standard deduction is significantly more generous, while some housing-related itemized deductions have been squeezed. The standard deduction for a married couple this year is $24,000, with an additional $1,300 for each spouse over age 65. So a couple with both partners over age 65 will get a $26,600 standard deduction. Those who itemize deductions face a $10,000 cap on the write-off for state and local taxes, which includes property taxes on the house; that cap applies to both individual and joint filers. In addition, interest on up to $750,000 of new mortgage debt is deductible, while the prior cap was interest on $1 million of mortgage debt.

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A homeowner with sizable charitable deductions or medical expenses may still find it advantageous to itemize deductions. But many seniors who have itemized in the past likely will find themselves switching to the standard deduction in 2018. Not itemizing means losing the tax benefit of a mortgage because the taxpayer won’t be able to write off the interest on the loan. “The new laws obviously change the dynamic on this,” says Lyle Benson, president of LK Benson and Co., a financial-planning firm in Towson, Md.

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For retirees who are homing in on their mortgage payoff date, the loan may not be throwing off enough tax-deductible interest to help make itemizing worth it. If your original mortgage had a balance of $350,000 and it’s down to only $60,000, most of the monthly payments will be principal, says Michael Landsberg, director of Homrich Berg, an Atlanta wealth-management firm. Mortgages throw off the most interest—and provide the most tax benefits—on the front end, so an older mortgage won’t provide much of a mortgage interest deduction. “The hurdle for itemizing becomes even higher,” says Landsberg, a certified public accountant.

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If you won’t benefit from itemizing, paying off the loan could be a sensible route tax-wise. But if you snagged a low interest rate for your mortgage, consider where the money you would use to pay off the loan is coming from and how much it earns. If you’re earning about 4% or so on the bonds in your portfolio, and paying about the same or less in mortgage loan interest, “you really have to step back and say ‘Am I better off paying off my house and reducing my bond portfolio a bit?’ ” says Robert Keebler, a partner with Keebler & Associates, a tax advisory firm, in Green Bay, Wis. Assess your asset allocation if you plan to draw from your portfolio. If your portfolio is overweighted in stocks, you might pull cash out to pay off the mortgage when you rebalance. Or if you are taking required minimum distributions from your retirement accounts, consider using that money to pay off a mortgage early.

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But before you pay off your mortgage, take a look at any other debts you have. If the interest rates are higher, consider knocking those debts off first. If you have a home equity loan, you might want to pay it off before the mortgage. The new tax law doesn’t allow a deduction for interest on either old or new home equity loans, except when used for home improvements.

And don’t forget to factor in the opportunity costs for the money you are using to pay down your mortgage. You could invest it instead, if you feel confident that you can generate higher returns than your mortgage rate. Or, like Leavitt, you could put it toward your living expenses and an emergency fund.

Even if the numbers don’t favor paying off the mortgage, finances may not be your only consideration. Some older homeowners feel more secure with their homes totally paid off. Others worry about running out of money in retirement, so they want a paid-off home as a lifeline, says Canniff.

If you are still a decade or so away from retirement and are sure you don’t want a mortgage in your future, take some steps now to reach that goal. Make an extra mortgage payment each year, apply a bonus or other windfall to your mortgage payments, or refinance into a 15-year mortgage to pay it off as quickly as possible, while you have income, says Ann Thompson, a Bank of America senior vice president.

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