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Should You Pay Off Your Mortgage Early, Before You Retire?

Some people enjoy the peace of mind that comes with a debt-free retirement. But warm and fuzzy feelings should be weighed against solid financial facts.

When it comes to paying off your mortgage, for example, first take a look at the interest rate. “If the rate on your mortgage is low, you might be better off holding onto your cash—or even investing it, assuming you’re reasonably confident you can get a higher rate of return than you’re paying on the loan,” says Rob Williams, vice president of financial planning at the Schwab Center for Financial Research.

Here are the pros and cons to consider before retiring a home loan.

Pros

  • Limited income: Your monthly mortgage payment may represent a significant chunk of your income. Eliminating this payment can greatly reduce the amount of cash you need to meet monthly expenses. 
  • Interest savings: Depending on its size and term, a home loan can cost thousands or even tens of thousands of dollars over the long haul. Paying off your mortgage early frees up that future money for other uses. While it’s true you may lose the mortgage interest tax deduction, the savings on servicing the debt can still be substantial. Besides, the closer you get to paying off the loan, the more of each monthly payment goes to principal, decreasing the amount you can deduct.
  • Predictable return: Investments can go up—and they can go down. But no longer paying interest on a loan can be like earning a risk-free return equivalent to the mortgage interest rate.
  • Peace of mind: Numbers aren’t everything, so if you’re determined to retire your mortgage, consider tapping taxable accounts first. “If you withdraw money from a 401(k) or an individual retirement account (IRA) before 59½, you’ll likely pay ordinary income tax—plus a penalty—substantially offsetting any savings on your mortgage interest,” Rob says.

Cons

  • Insufficient retirement savings: If you aren’t contributing enough to your 401(k), IRA or other retirement accounts, this should probably be your top priority. Savings in these accounts grow tax-deferred until you withdraw them.
  • Insufficient cash reserves: Rob recommends keeping a cash reserve of three to six months’ worth of living expenses in case of emergency. “You don’t want to end up house rich and cash poor by paying off your home loan at the expense of your reserves,” Rob says.
  • Higher-interest debt: Before you pay off your mortgage, first retire any higher-interest loans—especially nondeductible debt like that from credit cards.
  • Opportunity costs: One way to determine if investing the funds is preferable to paying off your mortgage is to compare your mortgage interest rate to the after-tax rate of return on a low-risk investment with a similar term—such as a high-quality, tax-free municipal bond (assuming the issuer is from your home state. You may have to pay taxes on out-of-state municipal bonds). If your mortgage is costing you less than you’d earn, you might consider keeping it.
  • Diversifying your investments: Maintaining your mortgage allows you to hold more of other asset classes. And overconcentration carries its own risks—even when it’s in something as historically stable as a home.

A middle ground

If your mortgage has no prepayment penalty, an alternative to paying it off entirely is to chip away at the principal. You can do this by making an extra principal payment each month or by sending in a partial lump sum.

This tactic can save a significant amount of interest and shorten the life of the loan while maintaining diversification and liquidity. But avoid being too aggressive about it—lest you compromise your other saving and spending priorities.

What you can do next

  • Know the numbers: A mortgage-payoff calculator can help you weigh the facts and figures of your particular situation.

  • Think it through: Paying off debt can bring peace of mind, but parting with the necessary cash may feel risky. Talk to a Schwab Financial Consultant about striking the right balance for you or visit a branch near you.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Investing involves risk including loss of principal.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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