Retirement planning rules tend to be very specific to individuals’ financial situation, lifestyle, retirement plans and location. But there is one rule experts tend to agree on: Pay off your mortgage before entering your golden years.
“When you look at where Americans spend their money, 30% to 40% is on housing,” says Joseph Montanaro, a certified financial planner at USAA. “When you look at retirement, you can create a much smoother income plan when you don’t have that requirement.” For retirees, reducing fixed expenses like housing provides more financial flexibility and less stress on an investment portfolio.
Most people in retirement are on a fixed income made up of savings, investments like a 401(k) or IRA, Social Security benefits and pensions. Not having to worry about making monthly mortgage payments can provide peace of mind, says Michael Eisenberg, a certified public accountant in Los Angeles.
Not having a mortgage payment will also free up cash flow. When you retire, the outflow of dollars changes as you may have other expenses, such as elevated health- care costs and discretionary goals. “If you sell the house, all that cash will be available for other purposes,” says Eisenberg.
If you don’t sell your house, there still are other things you can do with that asset if necessary. “In retirement, you can’t get unsecured debt because you don’t have any income,” says chartered financial analyst Robert Stammers, director of Investor Education for the CFA Institute. “You can get secured debt, and you’ll have your house.”
How to Pay Off Your Mortgage
Before working to pay off your mortgage beyond the monthly payments, Stammers suggests eliminating other consumer debt like outstanding credit card bills and creating an emergency fund that covers six months of expenses.
When determining the best way to pay your mortgage early, experts recommend keeping your available cash in portfolio accounts. If you’re going to liquidate your accounts to pay off your mortgage, ask whether it makes sense to use that money and leave yourself with no cushion, says Eisenberg. “You’re leaving yourself cash poor.”
Experts also recommend diverting extra cash to pay off your mortgage while you’re working by changing the amount and when you pay, here are a couple options:
Accelerated Mortgage Payments. “Split your mortgage payment in half and make payments every two weeks,” says Stammers. “You’re matching your payments with your cash flow, and you’ll make an extra two payments [or one monthly mortgage payment] each year.” If you have a $225,000 mortgage at 5% for 25 years, for example, by paying your mortgage biweekly, you can shorten your mortgage by about three to four years and save about $28,000 in interest payments.
Refinance into a lower rate. With mortgage rates sitting at historic lows, Eisenberg suggests refinancing. The national average commitment rate for a 30-year, conventional, fixed-rate mortgage was most recently at 3.49% as of July 26, according to Freddie Mac. If your rate is much higher than current interest rates, he suggests refinancing into a lower rate mortgage since this will lower your payments.
When you make payments on your new mortgage, experts advise keeping your payment the same to accelerate paying off your loan. This can still be beneficial even if you’re far into the mortgage, according to Montanaro. “This doesn’t change your cash flow but you can shorten the term of your mortgage if you leverage today’s low interest rates.”
Round up your payment. Pay more money each month, even if you only round up your payment, says Montanaro. If you’re payment is $1,110, for example, pay $1,200 instead. “Take a look at an amortization table to see what you need to do to pay it off within a certain time period.”
Keep your mortgage term at 30 years. Experts recommend keeping your options open with a 30-year fixed rate mortgage instead of refinancing into a shorter-term loan. Even though you can reduce your interest rate by about 0.70% with a 15-year instead of a 30-year mortgage, your payment will be higher.
“It’s better to look at your options and go with a longer term mortgage even though you might want to pay it off early,” says Montanaro. “If you lose your job, you’re not committed to a higher payment. You want to pay extra [money] every month instead of getting locked into a bigger payment.”
Paying off your mortgage can be an integral part of your retirement plan but this takes work. “You have to find money to plow into the mortgage,” says Montanaro. “On the verge of retirement, cash provides flexibility.”