Do You Need to Pay Off Your Mortgage Before You Retire?

The reality is, maybe not.

Although I've said at least 1,000 times that I never want to retire, my husband will want to begin wearing funny socks and hitting the links at some point. And so, like every other American couple, we must plan for life after retirement. And that includes how much we want to spend. Which expenses will we keep, and which will we jettison?

The frustrating truth

The answer to whether we need to pay our mortgage off before we retire is: "It depends." And yes, "it depends" is the most frustrating answer in the English language. What's right for you may not be right for us.

That's because it depends on where the money comes from. If you inherited money, won it in Vegas, or simply have enough lying around to retire the mortgage, it's an easy decision. Pay off your mortgage, particularly if it lifts a weight from your shoulders.

However, if you have to divert funds from somewhere else to pay off your mortgage, you need to calculate which plan of action leaves you with the most money in retirement. Here's what I mean.

Mortgage vs. low-yield investments

If you're paying more interest on your mortgage than you're earning through investments, paying off your mortgage is like giving yourself a raise. Let's say you have enough invested in municipal bonds to pay the remainder of your mortgage. If the bonds yield 2.5% (they sometimes yield far more) and your mortgage is 4.5%, it may make sense to sell your bonds and use the money to pay off your mortgage. As long as the fees associated with selling the bonds are low, you could trade an investment that carries a risk for a risk-free 4.5% return.

That said, look into tax implications first. Are you going to get hit with taxes for selling the bonds? And remember, paying off your mortgage means losing the mortgage interest deduction, if that's a deduction you normally take.

Mortgage vs. retirement account

According to Vanguard, the average return on a 401(k) account in 2020 was 15.1%. While the S&P 500 had an annual return of more than 20% between Jan. 2020 and May 2021, stocks (and retirement accounts) don't hit it out of the park every year. For example, Mid Atlantic Capital Group reports that 9.5% was the average rate of return on a 401(k) from 2015 to 2020.

If we use 9.5% as our benchmark for potential earnings on retirement investments, it's easy to see that investing will leave you with more money than paying off a mortgage with a 4.5% interest rate.

Let's say you owe $200,000 on a mortgage scheduled to be paid off in 15 years. With an interest rate of 4.5%, you'll pay just shy of $75,000 in interest over those 180 months. If, instead of focusing on paying your mortgage off, you were to invest the funds at 7%, it would become nearly $552,000 in 15 years -- $352,000 of which would be interest paid to you. By that time, your mortgage would be paid off and you'd have a larger nest egg put away.

Considerations

Anyone who has owned a house has probably imagined a day when the mortgage lender was paid in full. As you decide which "it depends" answer works best for you, ask yourself the following questions:

• Do I need the increased monthly cash flow paying my mortgage off would offer, or can I get by without it?
• Based on my projected retirement income, will I have enough money to make the monthly payment and cover the cost of maintenance?
• Will my partner be able to afford the monthly mortgage payment if I die before they do?
• Do I plan to use the equity in the house to pay for things like long-term care?
• Is the peace of mind I would gain by paying the mortgage off worth the returns I may miss out on by investing less?

One final thought

Unless we move in with a relative after retirement, we will always have housing costs. I recently investigated the wisdom of paying our mortgage off, and realized that even after paying the note in full, we'll still be making a housing payment. That's because 40% of our current mortgage payment covers taxes and insurance on the property. And taxes and insurance bills never go away. Once the mortgage company is paid off, we'll be responsible for covering those expenses.

The right answer for you boils down to whether paying your mortgage off before retirement will leave you with more or less money to spend each month. That said, there is no rule that says a mortgage must be paid off before retirement, particularly if you have invested wisely and can afford the monthly payment.