Your mortgage is probably your largest monthly expense. When you retire, you will have to get by on a fixed income. Eliminating your home loan payments before you stop working can make it easier to make ends meet after you retire. Before you decide to put extra money toward your mortgage, however, take a careful look at your entire financial picture to figure out if that’s the best option.
Reasons to Pay off Your Mortgage Early
The average homeowner spends tens of thousands of dollars in interest over the life of a mortgage. Paying off the loan early can dramatically reduce the total amount you will spend on interest.
Many people find it difficult to adjust to living on a fixed income after they retire and realize that they underestimated their costs or didn’t save enough. Not having to worry about monthly home loan payments when you’re no longer working can give you peace of mind.
When to Focus on Retirement First
If you started saving for retirement late, or haven’t saved as much as you would like, you may be better off putting more money in your retirement account than paying off your mortgage faster. A retirement account will benefit from compound interest. While it’s true that paying off your mortgage early can save you thousands of dollars in interest, the amount you can gain by investing in a retirement account may be greater.
Compare the average rate of return on your retirement investments to the interest rate on your mortgage. If the percentage you can earn by investing in an IRA or a 401(k) is larger than the percentage you can save on mortgage interest, focusing on retirement first may pay off more in the long run.
If your mortgage has a prepayment penalty, paying it off early can cost you money. The amount of a penalty may significantly reduce any benefit you could get by making extra loan payments.
If you don’t spend enough on mortgage interest to itemize your tax deductions, you may be better off putting money into your retirement account. Some types of retirement accounts will allow you to defer paying taxes on money you contribute, which can help you financially right now.
Consider Doing Both
Another possibility is to pay down your mortgage while also beefing up your retirement savings. Chipping away at your loan balance with extra payments can reduce the amount of money you will have to spend on interest and help you pay off the loan earlier. Making even modest payments above the amount required can result in substantial savings, while leaving room in your budget to contribute to your retirement account.
What Should You Do?
There is not one answer that applies to everyone in every situation. Carefully consider your mortgage balance and interest rate, how much you already have saved for retirement, your return on investment and when you plan to stop working. A financial advisor can help you choose the best option for your circumstances.