Should you pay off your mortgage before retiring?

Many people who are preparing for retirement ask us if they should pay off their mortgage. In an ideal world, you should pay off your mortgage. But for many people, their finances aren’t ideal. If that’s your situation, then there are times when it may not make sense to pay off the mortgage. I’m going to quickly take you through both sides of this strategy.

If you’re a good planner, saver and have been fortunate to live squarely within your means during your working career, then you’re probably on track to pay off your mortgage prior to retirement. If you’re debt free, it gives you substantially more flexibility to weather difficult financial markets once you start living off the returns from your retirement portfolio.

With no mortgage, you don’t need to withdraw as much to maintain your lifestyle. Our research on portfolio distribution rates indicates that in many situations reducing your annual withdrawals by just 1 percent of your portfolio value, for instance going from a 5 percent to a 4 percent distribution, can increase the odds by 20 percent of making your money last 30 years.

Here’s a simple example. Let’s assume your mortgage payment is $2,000 per month, or $24,000 per year. If you’ve got $1 million of retirement savings, you’ll need distributions of 2.4 percent just to pay the mortgage. That puts a lot of additional pressure on the portfolio. If you don’t have a mortgage, you don’t need to take these distributions and your odds of making your money last rise substantially.

But what if you still have a mortgage? Should you rush to pay it off? Probably not if your remaining mortgage balance is more than 5 percent of your retirement savings. If you pull a big chunk of dough out of your retirement plan to pay off the mortgage, you may do more harm than good. That’s because you’ll be significantly reducing the size of your retirement portfolio at the start of your retirement cycle, which is the worst time to suffer a decline. If that big withdrawal happens to coincide with the start of a bear market, your first 10 years of retirement will be pretty tough.

If you carry a mortgage, the real issue in retirement becomes not how much debt you carry, but how low you can get your monthly payment. Here’s an example, and to highlight the point I’ve simplified the math by assuming you don’t pay any interest on your loan. Let’s say you have a $300,000 mortgage at age 65 and you want to pay it off in 15 years. Even with no interest charges, that will cost $1,660 per month or about $20,000 a year for the next 15 years. But what if your bank gave you a 100-year mortgage with no interest? Then the payment is only $250 a month or $3,000 a year — no big deal probably.

The point is that if you carry a mortgage into retirement, you should consider stretching it out as long as possible and getting the monthly payment as low as possible. This basically gives you options. If the markets are bad your first 10 years of retirement (which is the most critical time), then you aren’t putting as much pressure on your distributions.

Conversely, if the markets are good your first 10 years, then you can take out some additional distributions and either pay down or pay off the mortgage. The point is to get time on your side to react to whatever the market presents. If interest rates are favorable, as they are today, and you’re going to retire with a mortgage, it may make sense to refinance to the longest term with the lowest monthly payment.

If you think you may want to refinance, it’s a good idea to do it while still working because it’s generally easier to qualify for a mortgage if you have a steady income. Although it sounds odd to consider a 30- or even 40-year mortgage when you’re 65, it just may make the difference between a more secure or more stressful retirement.