Everybody worries and everybody worries about retirement in a different way.
Almost everyone nearing retirement wonders whether they should pay off their mortgage. To answer the question yourself, start with the financial golden rule: get interest, don’t pay it. Real estate brokers, home developers and banks love the 30-year mortgage -- they have marketed long mortgages for generations. A 30-year encourages people to stretch to ever more expensive homes. That works for banks. A 30-year mortgage doubles the interest revenue for mortgage lenders. Marketing works. Despite the much lower cost of a shorter term mortgage, over 90% of mortgages are 30 year.
Example: In April 2018, a 30-year mortgage charged a 4.18% interest rate and a 15-year 3.75%. Borrowing $100,000 for half the time, lowers the total interest payment by 60% not 50% from $75,626 to $30,900. But why pay a bank anything? Put the mortgage interest payment in your own retirement account, you earn the interest, and the return accumulates tax free.
My conversation with two correspondents about their mortgages may help individuals make good mortgage payoff decisions for themselves.
First question: "Ms. Ghilarducci, I am over 60, but have two children still in school, one in college and one in high school. I have two homes, one is our residence and the other a vacation home. I have a 15-year loan (3.35%) on my home that matures in 2029 and a 30-year mortgage (4.25%) on the vacation home whose term ends in 2045. I can pay off one of these loans using stock I have now. After reading your article in Forbes, it seems the right thing to do, but which one should I pay off? Any thoughts you have will be appreciated. I understand that you cannot give me financial advice. Thank you."
My answer: I wrote "I think you already have the answer -- I am a teacher after all. What do you think the right answer is?" She shot back with exactly the right answer:
“Unless conventional wisdom is that you always pay off your home first in case something happens, I would pay off the second house and then put that payment toward the first because that one costs about $900 per month in interest and my home is about $500 per month in interest. The second house will cost about 260k to pay off, while my home is more like 180k, so that will use most of my stock... also may be a consideration.” I couldn't do better with that.
Second question: "My mortgage is about 400 dollars per month for principal and interest. I pay another 500 dollars to escrow to pay insurance and taxes. The tax and insurance do not go away if I pay off the mortgage early. I could pay off early but would do so by selling stocks with high appreciation or IRA shares with tax obligations. It seems that I am better off paying the monthly installments for the remainder of the mortgage than withdrawing the 34,000 dollars from my accounts to pay off the mortgage to save $1,200 this year and even less in the years to come. Mortgage rate is 3 5/8 percent per year."
My answer: If the cash you need to pay off your mortgage is earning a higher rate of return and liquidating triggers high transactions costs, paying off your mortgage may not make sense. But it probably does. Your question contained the false certainty your stocks will always appreciate. (Two weeks ago, the Financial Times suggested profits may be at their peak.) If you pay off your mortgage you guarantee yourself a 3 and 5/8 percent return. It is hard to get a guaranteed return. Assuming your stocks returns will always be positive and more than, say 3 and 5/8 percent is highly risky. In fact, we know your stocks' value will fall in the next recession. But tapping your IRA before you retire is not a good idea. May I suggest sprucing up your IRA by owning only index funds, you will earn more by paying lower fees. And, instead of withdrawing, cut your consumption in order to double up on the mortgage principal payments to cut interest costs.
Still not sure? Use a mortgage payoff calculator to analyze your choices. But do one thing, construct scenarios where your property taxes increase and your house does not appreciate. Simulate the 2008 crises and scenerio your home falling 20% in value. I like the calculators from Dinkytown – a former Wall Street Journal columnist Jonathan Clements turned me on to them. And Clements makes a relevant point about paying off your mortgage in an economic expansion. He writes, "... I like to see people in retirement with lower fixed costs. The lower your fixed costs, the less money you need to pull out of your portfolio every year. That’ll leave you in good shape if we get a period of rough financial markets." You don't want to pull money out of the stock market at distressed prices to make a mortgage payment.
In sum: there are two sides to retirement planning -- accumulate wealth and reduce spending. Paying off your mortgage is preparing for less income, more expenses, and a coming recession that might hit when you retire. Eliminating your monthly mortgage payment leaves room for fun and other expenses. Besides, paying off all debt transfers money from the bank's pocket to yours.
Unless you like banks and think they don’t make enough profit, you’ll want to keep the money for yourself. Paying off your mortgage means paying yourself first.