Should you prioritize debt or savings? This is one of the most common questions in household finance, and it comes up particularly in the field of retirement savings. For this example, let’s say you have a $650,000 IRA and a $120,000 mortgage. As you approach retirement, should you leave that money invested or pay off the mortgage?
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What Are Your Financial Goals?
The first thing to consider is why you want to pay off your mortgage. For instance, do you want to eliminate monthly payments from your budget, or are you trying to retire with as few commitments as possible? On the other hand, are you looking to maximize the value of your money? Maybe this is part of your estate plan and you’re hoping to leave an unencumbered property to your heirs someday? Or is this an emotional decision, as you simply don’t like the idea of retiring with debt?
Whatever your goals are will ultimately inform your strategy selection.
Many retirees hope to maximize their flexibility in retirement, allowing them to change their lifestyle and expenses at will. In this case, paying off your mortgage might be a wise personal move. Conversely, you might be trying to maximize dollar-value, trying to get the most out of your money. As we discuss below, in that case you may want to review the value of this debt against the value and risks of your portfolio returns.
Interest vs. Returns
The quick rule of thumb is to compare your mortgage rate with your IRA’s historical return rate. More specifically, if your mortgage rate is higher than your portfolio’s average return, you may want to pay off the debt. But if your returns are higher than your mortgage rate, you may want to prioritize your savings, while continuing nominal payments.
For example, say your portfolio is currently averaging an 8% return and your mortgage rate is 3%. By investing your money over at that potential 8% return, you’re gaining 5% more than you’re losing by paying 3% on your mortgage. That means investing is technically giving you more for your dollar than you would save by paying off the mortgage.
Beyond rates, consider the position of your mortgage. With a newer mortgage, most of your payments are likely going toward interest and paying it off early will save you more money in the long run. With an older note, each payment will go more towards principal and you’ll get less value out of accelerated payments.
Other Considerations for This Decision
Another important issue is cash flow. If you repay this mortgage early you will reduce your savings and, as a result, diminish your portfolio’s ability to produce income. If you don’t repay the mortgage, your portfolio will generate more money, but part of it will go to this fixed expense.
Review how each version of this plan would work. After taking your income and paying your bills, how much will you have left over? How does each version of these numbers meet your financial plans for retirement?
Finally, you’ll want to consider how this fits into your overall tax and investment plans.
If you itemize your taxes, mortgage payments are effectively reduced by the mortgage interest deduction. This probably won’t change the numbers significantly, as most households just take the standard deduction. However, it can be particularly valuable for a relatively new mortgage with higher interest payments.
Beyond that, how do you plan on changing your investment strategy as you enter retirement? Many, if not most, households shift to a more conservative approach once they hit retirement. That tends to create more security, but lower returns. Consider how that will affect your cash flow and the value of your returns against the mortgage rate.
At the same time, if you’ve decided to pursue income-based investments, think carefully before liquidating these assets. An income portfolio depends on strong principal to fuel its relatively low-rate/high-security assets. The more of your savings you spend on debt, the less income you will subsequently have.
Finally, consider your risk tolerance. Prioritizing returns over debt is a strategy that accepts some degree of risk. You will always benefit by paying off debt, and there’s always the chance that even safe assets will lose their value. While you can mitigate this risk by holding safer assets, make sure you have considered it.
Mortgage Tips
- A financial advisor can help you build a financial plan that accounts for your retirement, a mortgage and more. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Paying off your mortgage early is potentially beneficial way to manage wealth. It lowers your interest rates and frees up cash for additional investing. However, if you are looking to manage cash flow, here are some methods for lowering your mortgage payments.
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