Should You Carry a Mortgage Into Retirement?

Emily Brandon
August 12, 2009

Your grandparents probably paid off their mortgage before they retired. Those were the days of the mortgage-deed-burning parties. But today, a significant number of seniors are continuing to pay their home loans during the retirement years. Among homeowners ages 60 to 69, 41 percent still had a mortgage in 2007. And roughly half of these homeowners had sufficient assets to repay their loan. A new study from Boston College's Center for Retirement Research found that most households would be better off using the money to pay off their loan. But some retirees say they're holding on to their mortgage debt for tax breaks or to maintain liquidity. Here are some factors to consider when deciding if you should pay off your mortgage before you retire.

Compare returns. The typical 30-year, fixed-rate mortgage interest rate is currently 5.17 percent, according to the Mortgage Bankers Association. Some retirees keep their mortgages in hopes of achieving a higher rate of return elsewhere. But retirement savers are unlikely to beat that interest rate in low-risk investments such as bank certificates of deposit, treasury bills, and treasury bonds. "For almost all households, the after-tax cost of the mortgage is going to be more than the after-tax rate of return on those low-risk or risk-free assets," says Anthony Webb, an economist at the Center for Retirement Research at Boston College. Stocks have historically provided a higher rate of return, but it is not guaranteed that you will earn more than your mortgage interest rate. "The danger is that the household mismanages its finances and ends up losing the house," Webb says.

Weigh the tax breaks. The interest you pay on your home mortgage is tax deductible. But you only benefit from this tax perk if all of your itemized tax deductions--including mortgage interest, charitable contributions, and state and local taxes--add up to more than the standard deduction that most taxpayers receive automatically. The standard deduction is $11,400 for married couples and $5,700 for singles in 2009. Nearly 2 out of 3 taxpayers take the standard deduction, according to the IRS, which means that they're not getting a tax break on their mortgage interest. "If they do not have $11,400 or more of itemized items on their Schedule A, they are going to be better off taking the standard deduction, and it makes more sense to pay off their mortgage," says Jacob Gold, president of Jacob Gold & Associates in Scottsdale, Ariz., and author of Financial Intelligence: Getting Back to Basics After an Economic Meltdown.

Preserve your retirement accounts. It can be tempting to dip into your retirement stash to pay off your mortgage. However, your tax bite could jump if you withdrew a large sum from your tax-deferred retirement accounts in a single year. Withdrawals from 401(k)'s and IRAs are taxed as income. If you need $100,000 from your 401(k) to pay off your mortgage and you are in the 28 percent tax bracket, you will have to take out $128,000. "The more money you withdraw, the higher your marginal tax rate will be," cautions Greg Plechner, a certified financial planner and vice president of Modera Wealth Management in Old Tappan, N.J. Plus, if you raid your retirement account before age 59½, you'll be hit with an additional 10 percent tax penalty on the amount withdrawn. It's generally better to pay off your mortgage using taxable accounts. "If someone were to retire and they have a sizable portion of their estate in their after-tax investments, then it would make sense to pay off the mortgage," says Gold.

Consider refinancing. Refinancing from a variable-rate loan to a fixed-rate mortgage--especially now that mortgage interest rates are hovering near 5 percent--can help minimize mortgage payments in retirement. Plechner says that refinancing makes sense if your new mortgage interest rate is more than 1 percent lower than your current payments. "Keep an eye on fees, shop around, and always request a good faith estimate of the costs from the bank," says Plechner, who recommends refinancing only if you are less than halfway into paying off your mortgage. "The further you are into the term of the mortgage, the more the pendulum swings toward paying it off."

Keep some savings. Although eliminating your mortgage is a worthy goal, high-interest debt such as credit cards and car loans should be paid off before a mortgage. Plus, it's important to have some assets in case of unexpected medical bills, home repairs, or for other emergency expenses. Another solution is to find a more affordable house. "Instead of trying to pay off the existing mortgage, sell the house and downsize into something you can pay cash for," Gold says. "Then you don't have to exhaust your retirement account to pay for a house, you don't have to deal with the maintenance and upkeep, and you can travel a little bit more."