Should You Pay Off Your Mortgage?

Note: This article is part of Morningstar.com's 2020 special report, "Are You Able to Retire?" A version of this article originally published in July 2020.

Just a few years ago, anyone looking for safe fixed-income yields in retirement likely thought things were improving. After years of near-zero interest rates dating back to the Great Recession, the Fed began to increase interest rates starting in 2015, and retirees were able to find certificates of deposit yielding 3%.

Fast forward to now: The Federal Reserve has pushed short-term rates to zero as it attempts to mitigate the severity of the pandemic-induced recession. Available rates on CDs and high-quality bond funds remain exceptionally low.

Where can retirees go for a decent return? Maybe it's time to dust off that file folder labeled "mortgage."

If you’re carrying a home mortgage in the 3% or 4% range, accelerating your payments or retiring the loan entirely may offer a better return than letting cash sit around earning next to nothing--and the numbers can be even more attractive for paying down higher-rate debt on credit cards or student loans.

Wait, retirees don't typically have that kind of debt on their balance sheets, right? Not exactly: A rising number of older households are carrying significant debt, according to research done by Jason Fichtner senior lecturer at the Johns Hopkins University Nitze School of Advanced International Studies.

Fichtner found rising debt burdens among the near-retirement age population, especially among baby boomers born between 1951 to 1960. He also found rising debt/asset ratios. The findings raise the prospect of more Americans carrying significant debt into retirement, which in turn can squeeze standards of living and make them more financially fragile.

Another study from the Center for Retirement Research at Boston College found that Americans over age 60 were 24% more likely to have mortgage debt in 2015 than in they were in 1980. (Increasing homeownership accounted for 9 percentage points of that increase.)

Allan Roth, a certified financial planner and head of Wealth Logic in Colorado Springs, Colorado, laid out the argument for getting out of mortgages in a column for AARP. A mortgage, he argued, essentially is a "negative bond," where you pay the interest and the bank receives it. If you have the resources to do so, why not retire the loan and pay yourself?

He noted that most people aren't itemizing their deductions, so their mortgage interest doesn't help lower their taxes. In 2021, the standard deduction is $25,100, and most taxpayers don't have itemized deductions that exceed that threshold, according to data from the Tax Foundation.

If you’re not comfortable tapping a significant cash reserve to retire your entire mortgage, accelerating your payments may be an option--especially if your overall spending is down due to quarantining.

I called Roth to discuss this strategy further, and he pushed back on the notion of a conservative approach to staying liquid. “Why not retire the loan and simply make that monthly payment to yourself every month instead to rebuild your savings cushion?” he asked.

Roth acknowledged that economic and job market uncertainty might make it difficult to do these set-asides. “But there are other ways you could have access to liquidity in an emergency situation,” he added. Options include home equity loans or selling equities or bonds from your portfolio.

Financial planners who are compensated as a percentage of assets under management have a built-in incentive not to recommend mortgage payoffs, because a transfer of assets to a loan payoff reduces their compensation. But that doesn’t change the basic math in an ultra-low interest-rate environment.

Roth also knocked down one of the other typical arguments against retiring a mortgage: a desire not to put more “more money into your house.” It’s an interesting point, especially during a time of economic uncertainty that could certainly negatively impact real estate values. But what might or might not happen to the value of your home is irrelevant to the mortgage question, says Roth. A former corporate finance officer and McKinsey & Company consultant, he draws a comparison to the way companies think about operating and finance decisions.

“When you do net present value analysis in the world of corporate finance, you separate out operating and financial decisions, and buying a home is the same,” he argues. “Buying the home was the operating decision, and the mortgage was the financial decision.”

In other words, paying down a mortgage has no impact on the price you ultimately sell your house for--you’re simply getting rid of debt and boosting your cash flow.

Roth also argues that holding a mortgage distorts equity/fixed-income allocations in portfolios.

“Let’s say you have a $1.2 million portfolio, with half in stocks and half in bond funds,” he says. “You’d think that’s a 50/50 allocation, but if you also have a $200,000 mortgage, I’d argue you really have a net portfolio of $1 million that is allocated 60% to equities and 40% to bonds.”

Another argument that’s often made about carrying a mortgage: If you have a low-rate mortgage, invest the dollars you’d use to pay off the mortgage, because you have the chance to earn extra returns. But that really amounts to no more than leveraging your portfolio. As the authors of the CRR study note:

“Since mortgage interest rates are often a low-cost form of borrowing, households can leverage their portfolios by arbitraging the difference between the costs of borrowing and real rates of return when investing in markets. Such strategies can be risky, since the home is collateral for the loan and the asset values of investments and housing can decline. It is unclear that the average older household would have the ability to effectively borrow to invest, especially given low levels of measured financial literacy to be invested in the market.”

Fichtner’s research points to another potential benefit of retiring mortgage debt: increased financial resilience in the case of emergencies.

“A monthly mortgage payment is often the highest monthly bill a person has, and not having to worry about covering a mortgage payment when in retirement, especially if people are on a fixed income, allows for more financial flexibility to manage economic shocks,” Fichtner says.

“Bottom line, if someone has the financial flexibility to pay off their mortgage instead of keeping those funds in a vehicle returning barely above zero percent, paying off the mortgage would be a wise financial move that also creates the additional flexibility to weather economic shocks in retirement,” he concludes.

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to WealthManagement.com and the AARP magazine. He publishes a weekly newsletter on news and trends in the field at Retirement Revised. The views expressed in this column do not necessarily reflect the views of Morningstar.com.