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Paying off a Mortgage Before Retirement? It's Not Always the Right Move

Heading towards retirement, many people strive to become debt-free. That often means paying off a mortgage so you don’t need to worry about the monthly payments during your “leisure years.”

Yet it’s not always the right move. It all depends on how much of a cash cushion you’ve put in place for unforeseen expenses like home repairs or medical concerns, and whether there is other higher-interest debt that still needs tending to.

According to a 2016 study by Harvard University, more than 40% of homeowners 65 and older had mortgage debt on their primary residences. That’s nearly double the rate from two decades earlier. That’s partially because today’s soon-to-be-retirees are less debt averse than their parents.

The real test for a mortgage payoff is how your interest rate compares to expected stock market returns. If you’re carrying a mortgage with a 4% interest rate, history says that you can get a better return by investing the stock market.  The S&P 500, for example, has delivered a roughly 11.5% return since 1973 (with dividends included).

But here’s the big caveat. That 11.5% return is higher than average gains over the past century. That suggests we may be poised for a period of “mean reversion,” when the stock market delivers more muted returns for a stretch. Still, over the course of a decade or two, stocks are likely to deliver more robust gains that that 4% mortgage interest rate we just discussed.

For some people, refinancing a mortgage might be a better option. Depending on your current mortgage rate, you may be able to lower your monthly payments by refinancing and extending the life of the loan while locking in a lower rate.  These are good questions to ask a financial planner.

Lastly, don’t pull funds out of your retirement plan to pay off a mortgage. The tax bite on outsized withdrawals means that the potential psychological benefits of a reduced debt load is more than offset by the very real pain of a large tax bill.