Personal Finance

Money Matters: Reducing retirement savings to pay off mortgage may not be wise

Q. I’ve always heard that you should not have a mortgage in retirement so I may have done something really stupid in January. I was sick and tired of my credit card debt (which actually increased with holiday shopping expenses) and decided to refinance my house. I didn’t take out all of my equity but I added $50,000 to my previous mortgage amount and my current mortgage is around $150,000. The mortgage rate is fixed at 3.5 percent and my credit cards were charging between 8 and 12 percent. It seemed to make sense at the time but I want to retire in 10 years and I’ll still have 20 more years left on my mortgage unless I increase my payments from approximately $674/month to around $1,483/month. While working I could increase the payment to $1,000 but to make a $1,483 payment I’d need to reduce my current 401(k) contributions by $483/month. Since my interest rate is so low and the interest is tax deductible should I just leave things as they are? If I only make the $1,000/month payment I’ll still have a mortgage when I retire so should I reduce my 401(k) contribution and make the larger payment to ensure I won’t have a mortgage when I retire? If it matters, I’m single and make around $70,000.

A. As long as you keep your credit card balances low or better yet, paid off in full each month I think your decision to refinance and pay those off was a good one. By replacing the money owed on your high interest credit cards with a higher mortgage at a fixed low interest rate you have replaced bad debt with good debt. It’s true that the less debt you have when you retire the less money you will need to meet expenses. So, not having a mortgage payment by the time you retire is often touted as a worthy financial goal. But I would not recommend this if to do so you need to reduce your pre-tax retirement savings.

Based on your income and filing status, that $483/month you currently add to your 401(k) plan saves you 25 percent in federal income tax. That’s an additional $1,449 a year in taxes plus any state tax. To come up with the entire $483/month after taxes you’d need to reduce your 401(k) contributions by more than that amount. Unless you think you will be in a higher tax bracket in retirement, pre-tax investing is almost always a good idea.

If it won’t impact your retirement savings I would encourage you to make the $1,000/month payment for the next 10 years. This won’t allow you to be mortgage free when you retire but you will only have 122 mortgage payments left versus 240. By making this higher payment for just 10 years, you will reduce the interest paid over the life of the loan by $40,000. The mortgage interest deduction is only valuable to the extent it makes your itemized deductions greater than the standard deduction. Your standard deduction is $6,300 and based on your current payment plan the interest paid this year will be $7,409. Assuming no other deductions, in your tax bracket the mortgage interest deduction is worth around $277 (7,409 – 6300 = 1,109 * 25 percent). So, the value of the interest deduction is insignificant.