Payoff Your Mortgage, Invest, or Downsize?

Kiplinger’s Retirement Report published a thoughtful article recently that considers the question of whether it is best for retirees to fully payoff their mortgages or keep their money invested and continue to make monthly mortgage payments?

There certainly can be psychological rewards from owning a home free and clear and living debt free. But, financially, you may not always come out ahead following this course. As the article notes:

To pay off a mortgage, you’ll have to come up with a lump sum, probably from your portfolio. The basic rule of thumb holds that you should usually keep your mortgage if your after-taxinterest rate is lower than the expected after-tax returns from your investments… Imagine you have ten years remaining on a $100,000 mortgage at a 6% interest rate. If you stick with mortgage payments, you’ll pay $179,000 in interest and principal over the ten years. But if your investments earn 8% a year, $100,000 would grow to $215,900 in ten years. Forgoing those earnings by using that $100,000 to pay off the mortgage early effectively costs you $36,900…

In addition to the raw financial calculations, other considerations should be kept in mind. For one, using reserves to pay down the mortgage means you will have less cash available for unexpected expenses. Homes are illiquid investments and, with the economy in a crunch, it is not as easy as it once was to access your home equity via a home equity loan or line of credit.

Second, using money from a 401k or other tax advantaged account to pay off a mortgage could push you into a higher tax bracket. This is because the funds you contributed to the 401k account were tax deferred and accumulated tax-free. But when you take the money out to pay off a mortgage, the funds become taxable. Taking $100k out to pay down a mortgage might result in an unexpectedly large tax bill!

Downsizing can be a strategy that allows retirees to live mortgage free, keep portfolios invested and retain maximum financial flexibility. For example, a retiree with a $250,000 home and a $100,000 outstanding mortgage, could sell the home, buy a $150,000 replacement dwelling and live their retirement debt-free without ever touching their other investments.

Expanding your geographical frame of reference makes downsizing decisions even more attractive: if you live in a large, expensive city, you will find that smaller communities in the same region offer far more home for the dollar.