For many homeowners, the idea of entering retirement without a mortgage can be both financially and emotionally appealing. It can mark the end of a major monthly expense and the beginning of a new chapter.
However, everything depends on your financial situation and long-term goals; it may make more sense to prioritize other investments while continuing to pay down your home loan.
Here's what to consider before making the decision.
When paying off your mortgage makes sense
You’re aiming to reduce your monthly expenses: It could also be worth considering if your loan carries a higher interest rate than what you’d earn from low-risk investments, or if simplifying your finances ahead of retirement is a priority, according to Rob Williams, managing director at Charles Schwab Center of Financial Research.
“Paying off a mortgage can result in both financial and psychological benefits, but factors such as your mortgage rate, retirement savings progress and liquidity needs should be accounted for as well,” said Lindsay Theordore, a certified financial planner at T. Rowe Price.
Avoiding long-term interest costs: Depending on the size of your home loan, interest rate and term, interest payments can add up to hundreds of thousands of dollars over time. Eliminating that debt ahead of schedule could free up those funds for other uses.
Your mortgage rate is higher than the rate of risk-free returns: By paying off the mortgage, you're effectively earning a return equal to the interest rate you would have paid. For example, if your mortgage rate is 6%, then paying it off is like earning a guaranteed 6% return. If your mortgage interest rate is higher than what you'd earn from safe investments like savings accounts or government bonds — which is often true these days — it might make more sense to use extra money to pay down your mortgage instead of investing it elsewhere.
Simplifying your finances before retirement: “For some individuals, the satisfaction and peace of mind that come from eliminating a major debt like a mortgage far outweighs the potential return that could have been realized if that money were invested,” Theodore said.
Consult with a financial expert before making a decision. If you’re considering regular payments or a lump-sum payoff, “an advisor can help assess how this choice affects your long-term goals,” said Williams. If you decide to move forward with the lump-sum payment, consider using taxable accounts first. Withdrawing from retirement accounts, such as a 401(k) or IRA, before the age of 59-and-a-half can trigger income taxes and penalties, potentially negating any savings from reduced mortgage interest.
When holding off makes sense
You’re behind retirement savings: If your retirement plan shows you’re not contributing enough to your 401(k), IRA or other retirement accounts, boosting those contributions should likely take priority. These accounts grow tax-deferred, helping you build long-term wealth.
Your cash reserves are low: “Avoid becoming 'house rich and cash poor' by using funds to pay off your mortgage at the expense of emergency savings. It’s generally recommended to maintain a cash reserve covering three to six months of living expenses,” Williams said.
Carrying high-interest debt: Tackle paying off high-interest debt loans, especially credit cards, before focusing on your mortgage. Building a habit of paying off such balances monthly can reduce financial strain in retirement.
Potential for higher investment returns: According to Williams, if you have a mortgage with a low interest rate, especially one you locked in before rates went up, it might be more favorable to keep that mortgage rather than pay it off early. Instead of using extra money to pay down the mortgage, you could invest it in something low-risk (like a bond or savings account) that earns more interest than your mortgage costs you. That way, your money could grow more.
This approach could benefit individuals who are still working and have time before retirement, as they may be able to earn more from investments. If you're considering putting your money into riskier investments (like stocks), it's worth noting that those returns can fluctuate, and there's no guarantee you'll make more money.
Finding the middle ground
Not every decision needs to be made all or nothing. If your mortgage has no prepayment penalty, you might consider making extra principal payments or sending in a partial lump sum. This approach can save interest and shorten the life of the loan, while maintaining diversification and liquidity.
Pro tip: According to Williams, the key is to choose a pace and amount that fits your financial situation, so you don’t have to compromise other saving and spending priorities.
Theodore points out that “the debt paydown versus investing trade-off calculation depends on factors such as your risk tolerance, assumed investment return, mortgage interest rate and personal preferences.”
For some, the satisfaction and peace of mind that comes from eliminating a major debt, such as a mortgage, far outweighs the potential return that could have been realized if that money were invested.