Saving more vs. paying down mortgage

MarketWatchSeptember 1, 2013 

20111208 Mortgage rules

Which is better: To retire without a mortgage or keep the mortgage and retire with a bigger nest egg?


  • Reasons to not pay down mortgage

    • Mike Kenney, a consultant with Nationwide Financial, suggests you don’t pay down your mortgage unless you already have ample assets to cover all retirement income needs and/or are making the full allowable contribution to your 401(k).

    “The likely outcome of paying off a mortgage early is increased taxation on earned income now, though this would not apply with a Roth 401(k), and increased taxation due to the loss of a potential deduction later,” Kenney said.

    • Wharton professor Olivia Mitchell suggested that one’s house is a nondiversified, and potentially quite risky, asset. “In this light, hastening to pay off the mortgage may be the wrong thing to do,” she said.

    If you employer matches your 401(k) contribution, putting extra money toward that match rather than paying off mortgage early makes more sense, many say.

    • Another expert is fond of having cash in the bank or money in the market rather than a paid-off mortgage. “To me, cash is king,” said Michael Callahan, president of Edu4Retirement. “If you can amortize the payment of the mortgage, you have options by having the retirement savings on hand. You can always pay off the mortgage if the cash is available.”

    Plus, he said, it forces a better financial plan while working since past decisions need to be completed while future decisions need planning and commitments. And, Callahan said, having a mortgage “may keep people working longer so that they won’t overestimate the value of their retirement savings.”

  • Reasons to pay down mortgage

    • If your mortgage rate is variable and you think interest rates are rising, that makes paying the mortgage off more appealing, Mitchell said.

    • Paying down your mortgage before retirement will also help you lower your expenses in retirement. And that’s especially important since housing represents more than 30 percent of the expenses for average American 65 and older.

    • And some people, including Mitchell’s husband, believe that the “right thing to do” is to pay off the mortgage since it helps them sleep better at night, she said.

    • Having your mortgage paid off will let you qualify for a reverse mortgage.

Which is better: to retire without a mortgage, or keep the mortgage and retire with a bigger nest egg?

More Americans approaching retirement face what some describe as worrisome levels of debt, especially mortgage and credit card debt.

Consider: More than half (55 percent) of the American population ages 55 to 64 carry a home mortgage, and about the same fraction (50 percent) have credit card debt, according to a paper presented at the 15th annual Joint Meeting of the Retirement Research Consortium held earlier this month in Washington.

That debt isn’t going away after retirement. Among people ages 65 to 74, almost half had mortgages or other loans on their primary residences, and more than a third held credit card debt, according to the paper, Debt and Debt Management Among Older Adults.

Such debt can be hard to pay off during retirement, especially in the absence of earned income. Plus, in the worst of cases, such debt can lead to bankruptcy, said Annamaria Lusardi, a professor at The George Washington School of Business who, along with Olivia Mitchell, a professor at The Wharton School, University of Pennsylvania, is the co-author of “Financial Literacy: Implications for Retirement Security and the Financial Marketplace.”

Given the problems that debt can cause in retirement, we thought it worth asking the following questions: What’s the better tactic, to pay down one’s mortgage aggressively before retirement, and stop or perhaps reduce one’s savings for retirement? Or to keep saving for retirement and retire with mortgage debt? Or should you split the difference – save a bit less for retirement and pay down the mortgage some?

As with most things involving money, the answer depends on your personal situation.

“The question is not a simple one to answer as there are a number of variables that would come into play,” said Mike Kenney, a consultant with Nationwide Financial.

Those variables include current income, current savings, current tax rates, your Schedule A itemization before and during retirement, whether you have access to a Health Savings Account, your retirement income needs with and without a mortgage, your mortgage balance, the number of years remaining on your mortgage, and interest rates and opportunities to refinance – among many other factors.

Taxes also must be considered.

“There are tax advantages to pension contributions, and interest payments on mortgages are tax deductible, so one has to compare these advantages,” Lusardi said.

Kathleen Mealey, a financial counselor with Cabot Money Management, agreed, saying that contributing to a 401(k) and deducting interest payments from a mortgage could be beneficial, especially if it puts you in a lower tax bracket.

“If the answer will be a combination of both 401(k) contributions and paying off mortgage, work at keeping tax brackets low,” Mealey said.

A word of warning: You are likely to lose much of the benefit of deducting mortgage interest payments the closer you are to paying it off in full. Also, you get a tax deduction with your 401(k) contribution, but the deduction only defers your taxes, said Michael Kitces, partner and director of research for Pinnacle Advisory Group.

Mealey and others also suggested pursuing the tactic that offers the highest return on an investment.

“What is the mortgage interest rate and length of time remaining?” she asked. “Compare this with the 401(k) investment options. If the long-term rate of return on the 401(k) plan will be higher than the mortgage and there is a comfort level with the risk involved, it may not be advantageous to pay off the mortgage.”

For some, this is a no-brainer.

“With current low interest rates that are fixed for a number of years, a retiree can possibly have a better return on the money in a long-term objective portfolio than the 3 or 4 percent interest payment,” said Michael Callahan, president of Edu4Retirement.

On the other hand, if you aren’t earning much on your retirement investments, if you have low or negative returns, it might make sense to pay down your mortgage, Mitchell said.

“If one is holding assets in a money market mutual fund earning 0.5 percent while paying 5 percent on his or her mortgage, paying down that mortgage may be a clever strategy,” Lusardi said.

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