When It Pays to Have a Mortgage in Retirement—and When It Doesn’t

Finish your mortgage before you stop working.

That’s standard advice for those nearing retirement, but that may not be feasible for retirees who bought or refinanced homes later in life.

Those who can afford to pay off their mortgages might find that there’s now an argument for keeping their loans in retirement. Thanks to higher interest rates, investing savings in bonds instead of paying down the principal could yield enough to more than cover the cost of monthly mortgage interest.

“A year ago, the bill was really compelling for a mortgage prepayment,” said Allan Roth, a financial planner in Colorado Springs, Colorado. But with bond yields significantly higher today, the decision is “much closer,” he said.

Americans are far more likely to carry mortgage debt into retirement than previous generations, according to three of the four retirees profiled by the Wall Street Journal last week. According to the Federal Reserve, in 2019, the most recent year for which data is available, nearly 38% of 65-74 year olds had a mortgage or home equity loan for their primary residence. That’s an increase from 22% in 1989.

When interest rates were low, many homeowners refinanced into new 30-year loans. For many older borrowers, these refis have extended loan lives well into retirement, said Craig Copeland, director of wealth research at the nonprofit Employee Benefit Research Institute.

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“If you had a mortgage at 7% or 8% and you could refinance it down to 2%, why wouldn’t you?” he said.

Many retirees cannot afford to pay off their mortgage in one lump sum, or feel better off prioritizing other goals. Many people prefer to keep an extra cushion of cash in a bank or brokerage account rather than using it to pay off a mortgage because it can be difficult and expensive to tap home equity in emergencies.

For those who are able to pay off a mortgage, here are some factors to consider:

Two tariffs for comparison

If you can afford to pay off your mortgage now, the most important calculation is to compare your mortgage interest rate to the yield on an extremely low-risk investment like a Treasury note or a bond, says Mr. Roth. The goal is to see if you can earn enough after-tax interest to cover your ongoing mortgage interest.

Imagine someone with a $100,000 mortgage that charges a 3% interest rate. By paying off this mortgage, the homeowner would save 3% per year and have a guaranteed 3% return.

That person could also use the $100,000 to buy a short-term Treasury note, which would yield a slightly higher guaranteed return of about 3.49% in interest.

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“When bonds pay more, buy the bond and enjoy the extra money,” said Burt Hutchinson, a consultant in Wilmington, Delaware.

How about investing that $100,000 in stocks for an even higher return to cover your mortgage payments and make a bigger profit? According to Morningstar, since 1926, U.S. stocks have produced an average annual return of about 7% after inflation inc

– far higher than the interest rate that many home borrowers pay on their mortgages these days.

But those 7% returns are far from guaranteed. So far this year through Sept. 1, the S&P 500 is down about 16.8%. And from late 1965 through late 1981, the annualized return of the S&P 500, excluding dividends, was about 1.8%.

This illustrates the risks of such a strategy. “It’s not for the risk-averse,” said Elliot Dole, a consultant in St. Louis.

Consider the tax implications

Taxes can change the math when deciding to pay off a mortgage, generally in favor of paying off the debt.

Since the 2017 tax revision, which significantly increased the standard deduction, far fewer homeowners have taken a tax deduction for their mortgage interest payments.

Those who do should reduce the cost of their mortgage to reflect that tax advantage when deciding whether to pay off the mortgage, Mr Roth said.

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Above, if the homeowner with a 3% interest rate on a $100,000 mortgage receives a tax deduction for the mortgage interest, the cost of that mortgage drops from 3% to 2.34% after the tax benefit is accounted for. (This assumes that the homeowner is in a 22% tax bracket.)

The homeowner must compare the 2.34% after-tax cost of the mortgage to the after-tax yield he or she could earn on a treasury note. Someone in the 22% tax bracket would lose 22% of the 3.49% of the note’s interest in taxes. According to Mr. Roth, this leaves an after-tax return of 2.7%.

With the bond’s 2.7% after-tax yield exceeding the 2.34% after-tax cost of the mortgage, the strategy of buying bonds to pay the mortgage remains the more profitable choice, Mr Roth said.

However, if the homeowner doesn’t get the full tax benefit from the deduction, the bond’s 2.7% after-tax yield isn’t enough to cover the 3% mortgage. As a result, the taxpayer can earn a higher rate of return by paying off the mortgage.

Despite forecasts of a cooling housing market in 2022, US home prices are still reaching record highs, even as mortgage rates have risen sharply in recent months. WSJ’s Dion Rabouin explains what’s driving demand, signs of a slowdown on the horizon and what that could mean for the economy. Photocomposite: Ryan Trefes

How paying off the mortgage can affect liquidity

If you pay off a 3% mortgage only to find you need to tap into your home equity in retirement, you may regret it.

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Retirees with significant assets but low incomes may struggle to qualify for a new mortgage, Mr Dole said. A retired client of Mr Dole’s was recently denied a mortgage on her primary residence and had to sell assets to meet her cash needs.

Compared to other forms of housing debt, including home equity loans and reverse mortgages, maintaining a primary mortgage “can be an inexpensive way to fill funding gaps,” Mr. Dole said.

Even if the bill is cheap, some retirees may still feel more comfortable paying off the loan as soon as possible. Eliminating it can bring peace of mind and a sense of accomplishment, said Kevin Lao, a counselor in Jacksonville, Fla.

Write to Anne Tergesen at [email protected]

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