One of the most common questions we’re asked by retirees and near-retirees is: Should I pay off my mortgage?
We love questions like this because it allows us to use our favorite phrase as financial advisors: It depends!
While there’s no one-size-fits-all answer, here are some key considerations.
1. Where Are You in the Life Cycle of Your Mortgage?
Mortgages are amortized loans, which means that in the early years, most of your payment goes toward interest. Later in the loan, more of your payment goes toward principal.
If you’re still in the early stages of your mortgage, paying it off early could save you tens of thousands – possibly hundreds of thousands – of dollars in interest over time.
For example, on an $850,000 mortgage with a 5% interest rate, the total interest paid over 30 years could exceed $790,000. Paying it off early means more of that money stays with you instead of the bank.
However, if you’re near the end of your loan, most of your payments are going toward principal rather than interest. At this stage, your mortgage is relatively inexpensive, and you might get more value by putting your money to work elsewhere.
2. What is the Opportunity Cost?
When considering paying off a mortgage, it’s worth asking: What could your money be earning if it were invested instead of tied up in home equity?
The S&P 500 has grown, on average, about 10% per year since 1957 (1). While no investment is without risk, and we certainly wouldn’t recommend investing all your money in the S&P 500, this long-term return highlights the potential opportunity cost of paying off a low-interest mortgage instead of investing.
We can help you evaluate whether keeping your portfolio invested or paying down your mortgage is more likely to put you in a stronger financial position.
3. Where Would You Take the Money From?
We’ve had many conversations with folks who feel a pressure to pay off their mortgage once they’re in retirement. While it can make sense for some, many retirees and pre-retirees have much of their wealth in retirement accounts such as IRAs and 401(k)s, and there are important tax consequences to keep in mind.
Every dollar withdrawn from a pre-tax account like a Traditional IRA is taxed as ordinary income (plus a 10% penalty if you’re under 59 ½). If you’re in a high tax bracket, that could mean losing up to 37% of your withdrawal to federal taxes alone, and likely more depending on your state.
If you instead plan to draw from a taxable account – such as a joint account or a trust – you may need to sell investments first. This can trigger capital gains taxes, which, while generally lower than income taxes, can still be significant (3).
We can help you estimate what the tax consequences would be of withdrawing a large sum from your portfolio.
4. What is Most Important to You?
While we can try to do financial planning in a vacuum and only look at the dollars and cents, that’s not reality. Financial planning isn’t just about numbers – it’s about you.
Your goals, priorities, and preferences are of great importance. If carrying a mortgage causes significant stress, the peace of mind of paying it off may be worth it, even if it’s not the most efficient choice financially.
The Bottom Line
Both paying off your mortgage and investing can be smart moves, depending on your loan terms, overall financial situation, and comfort level with debt.
If this has been on your mind, feel free to reach out. We can help you determine what makes sense for your specific situation.
This commentary reflects the personal opinions, viewpoints and analyses of the Bourke Wealth Management employees providing such comments, and should not be regarded as a description of advisory services provided by Bourke Wealth Management or performance returns of any Bourke Wealth Management client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Bourke Wealth Management manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
(1) Investopedia
