Should You Pay Off Your Mortgage Early, Before You Retire?
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Zach – Hey everyone, Zach Holcomb here, back with this week’s blog we got Michael Reese with me, Certified Financial Planner. On this week’s episode, we’re gonna be talking about an article that I recently came across and this really stood out to me because this article, this is something that I hear from families that I talk with every single day. Now, Mike, this article is talking about, in retirement should you have a mortgage or not? Should you pay it off before you retire? Or can you have one in retirement? And they talk about a lot of pretty important things in this article. Now we’re gonna include this in the show notes, so if you wanna read this at the conclusion of the blog, we’re gonna include that in there for you. Now, this section specifically, this really stood out to me Mike. Now they say with interest rates being at record lows, including sub 3% mortgage rates it may be really tempting to refinance your mortgage or not to pay it off, but it’s worth keeping in mind that it’s hard to get a 3% guarantee investment return from any investment today. Now being reasonably confident, you get a higher rate of return, involves risk. Now it’s important to evaluate your risk before making a decision, right?
Michael – Yeah actually, and Zach, I think this is an excellent discussion because we’ve, I’ve come across this. Gosh, I all the time as you know, we’re, you know, clients are always asking us about this and, and people that we’re talking to, but as soon as you brought this to my attention I had two families just immediately, immediately pop into my mind. One family is already retired and the other has a couple years to go. So why don’t we talk about those two families a little bit so I could share with you what they were facing. So let’s talk about family number one, we’ll call them John and Mary, obviously not their names but they were retired and they had left on their mortgage, they had about 130,000 on their mortgage, but they’re sitting with over a couple 100,000 cash in the bank. And so the question they were asking is “Should we invest some of this cash in the bank? Or should we pay off the mortgage?” And it’s just like what you’re talking about, right? Because the mortgage, they had like a 3% mortgage and you know, all they were thinking about is, “Gosh I should be able to earn more than that. I mean, wouldn’t you think that we should earn more than 3% on an investment account?” So they’re like, well, so their minds were telling them you know, “We really should invest a chunk of this money. Cause we can make more than what we’re paying on the mortgage yet”. That seems like a no-brainer.
Zach – Right.
Michael – But, but their gut on the other hand, they’re saying “But man, it would be just so nice to have the house paid off.”
Zach – Right.
Michael – “You know, it would feel so good to have the house paid off”. So I actually sat down with them and we had this discussion and you know, Zach, when we went through their analysis, what we learned was now, by the way they had plenty of cashflow. So the mortgage payment was not a big deal for them.
Zach – Right, income was solid.
Michael – Yeah, they had solid, in their case, very solid income. Now, by the way, and let’s talk about after this, if it weren’t solid, what we would recommend but in their case, I simply said, “Look, your income solid, you can make the payment, no problem”. So mentally, when we went through the math, it’s like, yeah investing the money actually makes sense financially like mathematically you’re better off, over time but here’s the deal emotionally right? Emotionally just having it paid off, it just gave them such a sense of comfort. At the end of the day, I’m like, I just said “You know what guys, John, Mary, I recommend you pay it off”.
Zach – Right.
Michael – Mathematically probably not the smartest move, but you know what, for peace of mind, and retirement is all about peace of mind, it’s all about being able to go to sleep at night and not worrying about anything financially. I said, “Look, just pay it off. You’ll feel better, you’ll be happier, you’ll feel like you’ve got a, a better sense of accomplishment. Pay it off. It’ll be worth it”. And, and that’s what they did and they reported that that was actually once they wrote the check to pay it off, both of them told me they, you know, they went out to a great dinner and celebrated that night. It was really cool. If their cashflow was not as strong I would have said “No brainer paid off” No brainer. Because the only way that you make the decision to invest the money is if your cashflow is easily strong enough to pay the mortgage payment. The last thing we want is to have a disruption in your income streams or your incoming cashflow that would jeopardize being able to make a mortgage payment. So don’t, you don’t even wanna mess with it if your income flow is not as steady or as stable as you want it to be.
Zach – Right.
Michael – So that’s what you do if you’re retired. So couple of different scenarios there we went through and there’s there and like anything else Zach, I mean, is there ever a right or wrong answer here?
Zach – There’s not because everybody’s situation is different. So what applies to one family may not apply to another one.
Michael – That’s right, that’s right. And then, so that was a couple that was retired. So then there was another couple that came to mind who are still working. So let’s call them, oh, I gotta come up with new names for some reason, Dennis, the menace is in my mind right now. So I’ll go with Dennis and let’s go with Kathy or something I don’t know. Anyway, so Dennis and Kathy we’ll call them. This couple, they had saved a pretty good chunk in their retirement accounts and they were putting in like the maximum amount that they could. So the most you can put in your 401k, if you’re over the age of 50 is 26,000 a year. They were both doing that, both of them. So they were saving a boatload of money and that’s fine because they were trying to really save as much as possible for retirement. Their home still had a mortgage on it of about, it wasn’t a big chunk about, maybe about this was they lived in like an $800,000 home and they have like 110, $115,000 mortgage and there were a couple years away from retiring. But one of the things that we looked at for them is we noticed that, you know given the size, I mean, they had saved like a $1.5 million that 50,000 combined of annual contribution, wasn’t making a huge dent on their, on that $1 million, $1.5 million portfolio. But you know, where it would make a big dent is in paying down their home. Paying down their home. And so what we actually talked about in their situation, and by the way, this comes up really frequently when people are two to three years away from retirement. In a lot of cases, Zach, it actually makes sense to reduce your 401k contributions down to whatever you need to put in to get your company match. And then all that excess money you were putting in your 401k you should redirect that to paying down the mortgage because if you can enter into retirement with no mortgage at all that is the ideal position to be in. That’s the best place to be in, if you can do it. And in this case, this couple, we were doing the math cause they were already making extra payments on their mortgage, as you can imagine. And we calculated that if they were to reduce their, their contributions to their 401k, to the minimum amount, you know just enough required to get the match that that would allow about, oh, after tax, you know, maybe about $35,000 $40,000, it could be applied to the mortgage on top of what they were doing and they figured that they could have that mortgage paid off in three years at the most, maybe sooner. So in their case, it made more sense to redirect 401k contributions towards mortgage reduction, and that had a bigger impact on their comfort level in retirement.
Zach – Right, makes a lot of great sense, Mike and I’m taking some awesome notes when I’m about to retire in 40, 45 years, I’m gonna know what to do with my mortgage.
Michael – You’ve got a few years in front of you, don’t you?
Zach – Right, it’s down the road away. So those are some great scenarios talking about two different families in different stages of their lives. Now like we previously said everybody’s situation is different. So let’s talk about some of the pros and cons of having mortgage in retirement or before retiring and this is in the article as well. Remember this is gonna be in the show notes. So some of the pros, this is one we already touched on. If you’re, now here’s some of the pros, the first one is limited income you know, your mortgage, your monthly mortgage payment it may represent a significant chunk of your expense.
Michael – Right.
Zach – If you make that you’re gonna have more income.
Michael – Yeah, you know what that’s that think about it, I mean, if you think about where you spend money, especially once you enter into retirement, you know, I was talking to a couple the other day and they said, you know $6,000 a month would be comfortable for them.
Zach – Right.
Michael – But their mortgage payment, well it’s like 1500 of it. 25% of their payment was just mortgage. And, and so, you know, actually in their case, by the way we actually did something in between, we talked about refinancing their mortgage, we got their payments cut in half and that created a lot of cashflow. They didn’t have the money to pay off the mortgage but they could refinance, cut the mortgage payment in half and that freed up some cash flow. So, but yeah, that’s it, that was a huge chunk. So, you know, the, the lower the mortgage payment the more, the more free cashflow in retirement, always a good thing.
Zach – Right. Now, the next pro are interest savings because as you know, depending on the mortgage size and its term, a home loan can really just stack up an interest for tens of thousands of dollars over the long haul. So if you continue to pay those mortgage payments those costs can continue to stack up, especially in retirement.
Michael – Even at low interest rates, right? Even at low interest rates over time, you know, hey banks, there’s a reason they all have big buildings right?
Zach – Right.
Michael – They make money on these things And, and that means you’re paying. So, yeah. I mean, if you can get the mortgage paid off you’re saving a lot in interest that’s money that you keep in your pocket.
Zach – Right. So another pro is predictable return. Now investments, as we know, they can go up but they can also go down, but no longer paying an interest on a loan that can be like earning a risk-free equivalent to the mortgage interest rate.
Michael – Yeah, if your mortgage payment’s 3% and you pay that thing off, it’s like you’re saving to guarantee 3% a year, that’s that’s money in your pocket. I mean, hey, where can you get guarantee 3% like a savings account? Check I mean, that’s just hard to come by these days.
Zach – Right. And the last pro, this is one, you already touched up on and it’s a really important one. It’s peace of mind because nobody likes debt and especially in retirement, you want your income to go to yourself. You don’t want to be paying down bills that you don’t necessarily have to be paying, if you can afford to, you know, wipe it off your plate.
Michael – Yeah, Zach, this is by far the biggest one on the list. I would just tell you that as you know the clients we serve where their homes are paid off in retirement, they just, for the most part they’re just happier, more comfortable and so it’s always good to peace, like you said, peace of mind is everything in retirement right?
Zach – Now let’s talk about some of the cons and this is one we talked about, but it’s a little different now. One of the cons is insufficient retirement savings you know, if you’re not contributing enough to your 401ks or your IRAs or another retirement account that should probably be your top priority because savings in these accounts grow tax deferred until you take the money out.
Michael – Yeah, yeah, if you’re in a position and this normally applies of course, to those who are still working, right?
Zach – Right.
Michael – I mean, you gotta build your retirement savings up first and usually what happens is you get to a stage in life where the retirement savings get large, the home interest or the deck gets lower, and they there’s a crossover point, but yeah, I’m with you on that. Don’t pay your mortgage off if you don’t have enough in savings yet.
Zach – Right, now alongside insufficient retirement savings you know, you need sufficient cash reserves as well you know, you need to have that emergency fund built up. So you need to have maybe three to six months worth of living expenses and if you don’t have that built up, probably need to do that.
Michael – Yeah, especially these days right? With COVID it’s affecting a lotta people, they’re getting laid off and having those cash reserves make a big difference. Yeah.
Zach – Another con is high interest debt, you know, before you pay off your mortgage, you really should be wiping out any other high interest loans or other debt you have like credit cards. I mean, that can stack up on you quickly.
Michael – Yeah, yeah. You’re saying Zach, that we should pay off our credit card debt at 20% interest before our home loan debt at three, is that what you’re actually saying? What a crazy concept, right?
Zach – Who would have thought about that?
Michael – Yeah, I mean, that’s, that’s another one cons of, of you know, it’s and these, by the way, so far, most of the disadvantages to paying off your mortgage early I mean, there are basically, there’s an order of doing things, right? You make sure that, look, let’s check these other boxes off first, let’s make sure we’re good in these other areas before we start worrying about paying off what is, you know, the cheapest debt that we typically have.
Zach – Right. Now this next point, this is one you’ve touched upon as well and it’s opportunity costs. And you need to determine if maybe some, you know excess funds that you have is it worth it to invest the funds outside or should you just go ahead and pay off your mortgage? Need you to kind of weigh both sides of that.
Michael – Right, right. I mean, it’s like anything else in the world, you’ve gotta have a good balance you know?
Zach – Right.
Michael – You wanna have a balance between managing your debt and managing your savings and it’s all about, you know, it, it’s not about one or the other, it’s about both.
Zach – Right and kind of stacking onto that point as well, you know, you needed to look at and possibly, you know, diversifying your investments you know, if you maintain your mortgage you can hold other asset classes cause you have excess funds to kind of, you know, move your money around.
Michael – Right, so let’s, let’s talk about this for a minute because I’ve come across this recently I came across this super sweet lady, but she was in kind of a tough place because her husband passed away, she’s all by herself. She’s living in a house Zach about 1.1, $1.2 million home that’s paid for! You’re like that’s awesome right?
Zach – Right.
Michael – She has like a couple hundred thousand in investments. She is house rich and cash poor. And so I brought up to her, I said, “You know, you’re,” let’s call her you know, Joanne, that’s my mom’s name, we’ll go with that. I said, Joanne, based upon her financial condition she not gonna have an option, she she’s got to sell the house. She’s got to sell the house. Do you think that’s what she wants to do? Does she wanna sell the home?
Zach – Probably not.
Michael – No. Can she get a mortgage on the home right now? No. So right now, if she wants to stay in the home she’s got one option, she’s gotta look at doing a reverse mortgage and even that, those aren’t gonna give her enough money to even stay there. Bottom line she’s gonna have to sell the home, not an option, it’s a, it’s not a choice. It’s, she’s gonna be forced to sell the family home and we’re never wanted to do it. Well what if she had a mortgage, but more of that money invested like we just talked about a minute ago. What if they had a good balance between, you know, their savings and their, you know and their debt. Had, they had a better balance, she could’ve stayed in the home. She could’ve had an investment portfolio that could’ve been used to help pay down the mortgage and some income would have been a lot better position.
Zach – Yeah.
Michael – But you know what? They focused on, that to them their whole life just pay off the house, pay off the house, that was the number one goal. Yeah, guess what? That number one goal is basically cost her in retirement and it’s forcing her to sell the house, the one thing they wanted a house paid for, now, they don’t have any more. Well, she doesn’t have it, he’s gone. She doesn’t have it because they weren’t balanced, they weren’t diversified with their holdings. So good list of pros and cons there’s Zach.
Zach – Yeah, so just to kind of wrap up this week’s discussion, you know we went over some hypothetical scenarios, we went over some pros and cons but if you’re someone who finds yourself with this question on your mind, you know, should I have a mortgage or pay it off if I’m transitioning or already in retirement, you know, what should my first step be? Because there’s a lot of moving parts to answer this question.
Michael – Yeah, great phrase, lots moving parts. And so our answer is probably about the same as it is every week. This is why you pick up the phone and talk to us right? Let’s let’s put the pencil to the paper, let’s, let’s build the spreadsheets, let’s build the, what-if analysis and let’s figure it out. All right? Let’s figure it out together, let’s see what makes sense in your unique circumstances. So again, if you’re already a client and you’re watching this, you know we’re coming up, it’s November, it’s review meeting month you know, give us a shout during our review meetings we can talk about that. If you on the other hand, you don’t work with us for some reason and you just want to know Hey, what would make sense for you? Give us a shout. I mean, our number is 512-265-5000, give us a call. We, talking is free right? It’s free to talk. So let’s have that conversation, let’s see if we can be helpful.
Zach – Awesome. Everyone, thanks so much for joining us. Any last thoughts, Mike?
Michael – All, I wanna say is, since I say it every week retirement should be the best time of your life. You work your entire life, you’re saving money, you deserve to enjoy the retirement of your dreams. So all we need to do together, let’s make some smart financial choices together. This week it’s about your home but let’s make smart financial choices together so that you can truly enjoy your best that is yet to come. So Zach great being here, everyone, thanks for joining us and we’ll talk to you again next week, right?
Zach – Yep see you guys soon! Thanks.