One of the major financial milestones that many of us aim for on the road to retirement is paying off the mortgage. Increasingly, though, retirees have mortgages.
As you progress toward retirement, or if you are already in retirement, you might be wondering if it’s the right thing to pay off your mortgage, just to have that obligation off your chest and ensure that you own your home. On the other hand, you might decide that it makes more sense to keep your money in your investment portfolio, where you can keep earning 7% to 10% in annualized returns in an attempt to offset the 3% or 4% you might be paying on your mortgage.
There is no one right answer to this conundrum. Instead, you need to consider the risks and rewards, and your own situation. A good financial planner can help you manage your expectations and understand the options that are likely to work best for your situation.
Liquidity vs. Cash Flow
Once you pay off the mortgage and no longer have that obligation weighing on your monthly cash flow situation, you might feel a sense of relief. You don’t have to worry about making the monthly mortgage payment, so you have more cash each month. This can be a benefit to your finances in retirement.
On the other hand, tying your cash up in illiquid home equity has its own downside. You might be pay off your mortgage quicker, but what happens if you need access to that cash down the road? It’s harder to convert your home equity into ready cash, especially if housing values drop and your home isn’t worth as much.
In some cases, it can make sense to downsize during retirement. That way, you free up some liquid capital, while at the same time maintaining better cash flow (whether you no longer have a mortgage payment at all, or whether the mortgage payment is smaller).
Should You Sell Your Stocks to Pay Off Your Mortgage?
Once you retire, you begin living off the income generated by your portfolio. This can include dividend and interest income, but it also likely means that you begin selling some of your stocks to get the cash you need for living expenses.
Prior to retirement, it can make sense to put your money into your long-term stock investments (particularly funds), rather than rush to pay off your mortgage. Paying down your mortgage aggressively can mean a guaranteed return of 3% or 4% annually, but you miss out on the chance to build wealthy by compounding at an annualized rate that might be twice as high.
The equation might change as you approach retirement, or once you retire. When you have a long timeframe to recover from some of the down markets, and when you aren’t drawing down your portfolio to pay for daily expenses, drops in the stock market aren’t as important. Later, though, you might be forced to sell stocks when they are down because the money is needed during retirement. If you keep the mortgage, you run the risk of selling stocks at a loss in order to make that mortgage payment. If you could sell your stocks after they have gained, and use the proceeds to pay off the mortgage, you might have less need of the cash later. It’s easier to cut back on expenses when the market is down (and you have to sell at a loss) when you don’t have set obligations like a mortgage.
In either case, the downside is that you are drawing down your portfolio. If you keep your mortgage, you draw down your assets each month in order make your mortgage payment. In the other situation, your portfolio takes an upfront hit.
If you are close to paying off your mortgage, the upfront hit might not be that big, especially if you are in a position to liquidate while the market is high. On the other hand, if you still have a large amount left on your mortgage, the big upfront hit to your portfolio means fewer assets to earn interest during retirement. This can be a problem later. If you can handle the risk, going slowly and hoping that your long-term portfolio returns will still offset the interest you pay on your mortgage might be the solution for the combination of a smaller portfolio and a larger mortgage balance.
Everyone’s situation is different. You need to consider the impact of paying off your mortgage on your long-term cash flow, access to liquidity, and what it will do to your investment portfolio. Don’t forget about the tax implications as well. Consult with a knowledgeable financial planner to help you examine the options and create a plan that works for your unique situation.
Thanks for checking our this article. If anything we’ve written sparks a question, please let us know. Life is all about communication and financial planners love to answer questions! Feel free to get in touch with either John or me if you have questions.