“Should we pay off our mortgage before we retire?”
This is among the most common questions I get from clients and “Money Matters” listeners (tune in from 9-11 a.m. Sundays on WSB radio (News 95.5 and AM 750 WSB). I most recently heard it from a couple who are on their final approach for retirement.
Let’s call them Rose and Jim Jackson. The Jacksons had set their sights on paying down their mortgage early and have been adding a little extra to their payment each month over the years to chip away at the balance. Today, Rose and Jim are both 59 and are looking to retire in five years, when they hit 64. They have about $100,000 left on their mortgage, with plans to pay it off before they enter retirement.
After reviewing the Jacksons’ financial situation, I was able to provide the Jacksons with an answer. I told them, “In my opinion, yes, you can pay off your mortgage.” In fact, I told them that, if they wanted, they could make a final lump-sum payment that day!
I'm a big believer that being mortgage-free can help provide a foundation for a happy retirement. That's because the research for my book, "You Can Retire Sooner Than You Think," showed that the happiest retirees were four times more likely to have their mortgage paid off within the next five years versus unhappy retirees.
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Now I know that there are arguments against paying off a mortgage early, especially if the mortgage carries a low interest rate. So, let’s talk about that.
Some financial professionals may have looked at the Jacksons’ situation much differently. The couple have a 4 percent interest rate on their mortgage. They also have the $100,000 available to pay it off in full today with after-tax savings. The argument against paying off their mortgage today is that the Jacksons would be better served by investing their savings. This way, some financial pros would argue, the couple could garner an 8 percent return over time in stocks.
Let’s run the math both ways. If the Jacksons pay off their mortgage today, they would be saving approximately $15,000 in interest. If they waited to pay off the mortgage and instead invested their $100,000 and, assuming they earned 8 percent, they would earn about $8,000 per year. Over the next five years, they may end up with an extra $40,000. Subtract the $15,000 they would have paid to the bank, and they have another $25,000 left over. Sounds like a good deal, right?
Maybe, and maybe not. Consider this: What if the stock market doesn’t go up for a year, or two, or five? Or what if we get into a rut as we did in the 2000s when markets were relatively flat for a decade? Where does that leave you? Well, you’re still out the $15,000 to the bank for the mortgage, but you haven’t pulled down that theoretical 8 percent in returns, so this strategy has gone bust.
The average investor doesn't necessarily make a steady 8 percent per year return. Not paying off the mortgage means trading a certain 4 or 5 percent return for the possibility of a higher return.
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Back to the Jacksons: They were in a great position to pay off their mortgage and sail into retirement with one fewer line item (and it was a hefty one) on their monthly budget. Not everyone is so fortunate; of course. Only about 25 percent of owner-occupied housing units are without a mortgage, according to a 2016 study by the American Community Survey.
But since we know that paying off a mortgage can create tremendous peace of mind and happiness during retirement, let’s prioritize that goal. Here are four ways to make this dream a reality:
1. Go low to aim high. Keep your required mortgage payments at or below 15 percent of your gross monthly income. The mortgage and real estate industry will often cite a more aggressive 30 percent, but a lower percentage gives you greater ability to pay down the debt faster.
2. Use an early payoff calculator. There are several early mortgage payoff calculators available online. One example is Bankrate.com. This (or another) calculator will help you determine how many years you can trim off your loan by adding a few hundred dollars each month on top of your regular payment.
3. The differences between weekly versus monthly payments. Simply cut your mortgage payment in half, and pay that amount every two weeks. With this method, if your mortgage payment is $3,000 a month and you opt for the two-week payment schedule, you'll pay an extra $3,000 that year due to the way that the calendar falls. The best part? You may not even realize you are paying extra.
4. The one-third mortgage rule. This one is straightforward but should only be used as a guide. If you can pay off your mortgage using no more than one-third of your nonretirement savings, consider writing a check today. For example, if you owe $40,000 on your home and have $150,000 in savings (not including your 401(k) or IRA funds), you are within the one-third rule. Once you pay off your mortgage, you'll still have a sizable cushion left over, which is the optimal situation.
It is a joyous day, indeed, when you know you own your home free and clear. So, no matter where you are on your retirement timetable, take steps (however small) toward getting your mortgage to a zero balance. Not only will you be in a position to spend more money on the activities you love and cherish, but you’ll also likely have a greater sense of security and peace of mind.
Wes Moss has been the host of “Money Matters” on News 95.5 and AM 750 WSB in Atlanta for more than seven years now, and he does a live show from 9-11 a.m. Sundays. He is the chief investment strategist for Atlanta-based Capital Investment Advisors. For more information, go to wesmoss.com.
DISCLOSURE
This information is provided to you as a resource for informational purposes only and should not be viewed as investment advice or recommendations. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.
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