November 12, 2015
Mortgage Payoff? Freedom vs the Math
Financial planner Diahann Lassus views as misguided the “obsession” some baby boomers have with paying off their mortgage before they retire.
But Jane Rose, who has done just that with the loan on her home in Cherry Hill, New Jersey, has discovered how liberating it is. “I’m such a happy camper,” she said.
The math versus the emotion, the rational versus the irrational, head versus heart – that’s a simple way of framing a complex issue. Many boomers looking ahead to their retirement years are grappling with whether to pay off their mortgage before they retire or shovel any spare funds into their employer’s 401(k). Both arguments have merit for very different reasons.
First, the math. The alternative to paying off the mortgage – extra funds for the 401(k) – will provide more savings, more net wealth (assets minus debt), and more financial flexibility in retirement, according to many financial planners and an economist here at the Center for Retirement Research (CRR).
“There are few problems in life that aren’t mitigated by having a lot of money,” says Anthony Webb, CRR senior economist.
Indeed, directing extra contributions to a 401(k) is particularly attractive to well-heeled boomers in high tax brackets, who benefit the most from having both tax breaks: the federal mortgage interest deduction and the 401(k) tax deferral for contributions.
Other considerations, however, can tilt the balance toward paying more on the mortgage.
The mortgage interest deduction isn’t as valuable as it was when mortgage rates were higher and generated a larger deduction. Tax rates also generally decline in retirement, when incomes are lower. Those who expect to have low or zero tax rates in retirement will get little or no tax advantage from holding on to a mortgage and keeping their savings in a 401(k).
Investing a larger 401(k) balance in the stock market, with its high expected return, is also risky – and pursing this strategy hinges on being able to bear that risk. Rose, who paid off her mortgage, warns against “assuming the 401(k) will just make money. They can lose money.”
Then there’s the emotion. “It’s rarely about the numbers only,” said Rose, who is retired and vice president emerita at RTD Financial Advisers.
She was pleasantly surprised by how comfortable she felt being mortgage-free. “I have no car payments. I use credit cards and pay them off. I have no debt. No other payments.”
Perhaps the emotional downside of paying off the mortgage is having less saved for those unexpected expenses like medical bills. Lassus urges that those who are driven to pay it off should consider that “their money is just getting stuck” in an illiquid asset – the house. If it needs a new roof, where will they find the money to fix it? Having more savings provides financial flexibility, including the ability to eliminate the mortgage later.
So here lies the dilemma: the comfort of having reserves but a mortgage vs the comfort of owning a house, free and clear, but having less savings.