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Should You Pay Off Your Mortgage Before Retirement?

Tom Sightings

Owning a home can lead to a comfortable retirement. In theory, you buy a house when you're 30, faithfully make the mortgage payments for 30 years and at age 60 you own your house, free and clear. Now you have a solid nest egg and can sail into a worry-free retirement.

But more often, here's how it works in practice. You move from a starter home to a bigger house, with a bigger mortgage. You refinance to get a lower interest rate and take out some money in the process. And at age 60 you're still paying a mortgage.

[See: 10 Ways to Reduce Your Housing Costs in Retirement.]

According to the Federal Reserve Board, over a third of homeowners ages 65 to 74 are still burdened with monthly mortgage payments, with an average balance of $118,000. You might have that amount or more in a 401(k) plan. Is it worth it to draw down your retirement savings, and perhaps sell off other investments, to pay off your mortgage? The answer depends on your individual situation. Here's how to decide whether to pay off your mortgage before retirement:

When to Keep Your Mortgage:

You don't have enough money. If paying off the mortgage will make you cash poor and unable to cover your bills, then don't do it. As far as debt goes, a mortgage is about the best loan you can have.

The money is tied up in other investments. Even if you do have the financial resources to pay off your mortgage, it doesn't make sense if the money is already invested in solid assets that generate income and appreciate over time. Also, if you have large unrealized capital gains and would be hit by a big tax bill, it's probably not worth it. Remember, money coming out of an IRA or 401(k) is typically subject to personal income tax.

You have other loans. A mortgage carries a lower interest rate than most other loans. So if you're carrying a credit card balance or have other high interest debt, pay that off first.

You think inflation is coming back. Housing prices rise with inflation. With a mortgage you capture the increase while paying back the loan in ever-cheaper dollars. Also, interest rates typically rise with inflation, but you benefit from a mortgage fixed at a lower rate, at least for a period of time.

You're still working. Those who are still on the job might be better off building an emergency fund to cover life's sudden surprises and contributing the maximum amount to an IRA, 401(k) or other retirement account.

[See: 10 Tips for Finding a Great Place to Retire.]

When to Pay Off Your Mortgage:

You have a lot of cash. If you have extra money sitting in a money market fund or low interest bank account, it makes sense to use it to retire a higher interest rate mortgage. Bonus: With no mortgage your monthly bills are lower.

You have access to a home equity loan. You don't need a lot of cash on hand if you can access money if you need it for a major expense, such as a medical bill or home improvement. You also have the fallback option, later on, of taking out a reverse mortgage.

You can't take advantage of tax savings. If you don't itemize on your taxes, you miss out on the mortgage tax deduction. This makes your mortgage more expensive and may tip the balance toward paying it off. The new tax plan working its way through Congress may increase the standard deduction and limit the mortgage deduction, which may wipe out your real estate tax savings anyway.

[See: 10 Places to Retire on a Social Security Budget.]

You're looking for peace of mind. Paying off your mortgage is like making a risk-free investment, with no management fees. If you have a 4 percent mortgage you're getting a 4 percent return, compared to barely 2 percent on a risk-free Treasury bond. Besides, knowing your house is paid off could help you sleep better at night. Of course, as a homeowner you still have to pay real estate taxes, utilities and maintenance. But you can delay repairing a cracked window a lot easier than you can put off the bank.

You want to set up a comfortable nest egg. A house is a big asset. It's yours to live in, share or leave to your kids. And if you decide to downsize, the profit from the sale of your house goes to you, not the bank or the government, thanks to favorable tax treatment of capital gains from a primary residence.

Tom Sightings is the author of "You Only Retire Once" and blogs at Sightings at 60.

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