There’s no doubt that not having any debt can give you a certain sense of freedom. When you don’t owe anything to anybody, the money you have is yours to do with as you wish—a great retirement dream scenario. But as we all know from experience, reality can be a bit different.
In an ideal world, none of us would have any debt—ever. And we’d certainly pay off our mortgages, credit cards, and car loans before we retire. But that’s not always possible. And sometimes, it’s not even the best thing to do. As I discussed a bit in My Top Ten Recommendations on page 3, debt isn’t necessarily negative. In fact, in the financial world there’s a common distinction made between “good debt” and “bad debt.” But you have to know the difference. And to keep debt from ruining your plans, you also have to figure out how much debt you can comfortably handle on your retirement income. Here are some ways to go about it.
Deciding whether to pay off your mortgage early or keep a mortgage is a common financial dilemma. A mortgage represents a major monthly expense so being debt-free can feel very freeing. However there are also potential benefits to keeping a mortgage strategically. In this article, I’ll explore the nuances of this decision to help you determine the right path for your unique financial situation.
The Allure of Being Mortgage-Free
Owning your home free and clear is an admirable goal Here are some of the biggest advantages of paying off your mortgage early and becoming debt-free
Increased Cash Flow
The most obvious benefit is no longer having that monthly mortgage payment. For most homeowners, it’s their single largest recurring expense. Eliminating that frees up significant cash that can be used for other priorities like saving for retirement, college funds, or travel.
Flexibility and Peace of Mind
Without a mortgage obligation hanging over your head every month, you have much greater flexibility in your lifestyle and spending. Job loss or unexpected expenses are less catastrophic when you don’t need to worry about covering the mortgage. There’s simply less financial stress when you own your home outright.
Protection Against Foreclosure
If you fall on hard times, having no mortgage insulates you from the risk of losing your home to foreclosure. This gives you time to get back on your feet without becoming homeless.
Guaranteed Return on Investment
When you pay off your mortgage, you are essentially getting a risk-free return equal to the mortgage interest rate you would have paid. That can be preferable to investments with higher returns but more risk.
Tax Implications
While mortgage interest is generally tax deductible, that benefit goes away when the mortgage is paid off. But for some, the trade-off is worth eliminating the debt.
Potential Downsides of Being Mortgage-Free
While being debt-free sounds idyllic, there are also some potential drawbacks to consider:
Lost Opportunity Cost
Money used to pay off the mortgage could potentially get better returns if invested elsewhere. Even with today’s low interest rates, investment returns tend to exceed mortgage rates historically.
Reduced Liquidity
With a large portion of your assets tied up in home equity, you have less flexibility to access cash in the case of an emergency. Options like home equity loans and lines of credit are useful liquidity tools.
Missed Tax Benefits
You lose the ability to deduct mortgage interest after paying it off. For higher income households, this deduction can provide substantial tax savings each year.
Higher Estate Taxes
With no offsetting mortgage debt, more of your assets will be exposed to estate taxes when passed on to heirs. Proceeds from a home sale may also face capital gains taxes.
The Potential Upsides of Strategically Keeping a Mortgage
On the flip side, here are some scenarios where keeping a mortgage can make good financial sense:
Leveraging Low Interest Rates
Today’s historically low mortgage rates allow you to keep debt cheap. You can invest the money that would have gone towards paying off the mortgage for potentially higher returns.
Maintaining Liquidity
Keeping your assets more liquid in other investments gives you easy access cash for emergencies, big purchases, or new investments.
Ongoing Tax Benefits
You can continue deducting mortgage interest for tax savings. For high income households, this benefit is often substantial.
Asset Diversification
Rather than tying up all your wealth in your home, you remain diversified across various asset classes like stocks, bonds, real estate, etc.
Key Factors to Consider in Your Decision
With pros and cons on both sides, how do you decide what’s right for you? Here are some key factors to weigh:
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Your risk tolerance – Are you comfortable taking on debt and market risk to potentially earn higher returns? Or do you prefer the certainty of being mortgage-free?
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Your income stability – With a more stable income, you can more safely take on debt than if your income fluctuates.
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Your tax situation – Do you benefit significantly from mortgage interest and property tax deductions?
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Your investment goals – Do you have plans to invest excess funds? Or priorities like college savings?
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Your retirement timeline – The longer your timeframe, the more you can leverage low mortgage rates.
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Your mortgage terms – Lower rates, fixed terms, and shorter durations favor keeping a mortgage.
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Your other debts – Consider paying off higher interest, non-deductible debt first before focusing on your mortgage.
Finding the Right Balance for You
While being mortgage-free is rewarding for many, it’s not necessarily the optimal financial move in every situation. As with most money matters, the “right” decision depends on your unique circumstances and priorities.
Here are two scenarios that illustrate customized solutions:
John is 58 years old, plans to retire in 7 years, has a stable income, and is risk-averse. For him, the certainty of having no mortgage payment in retirement outweighs the lost investment opportunities. He decides paying off his mortgage aggressively is the right move.
Mary is 42 years old, has 2 kids nearing college age, and has a sizeable investment portfolio. She wants ready access to funds for college, so the liquidity and continued tax benefits make keeping her mortgage strategic. Her investments should earn more long-term than her low 3.5% mortgage costs her.
The best approach is to run the numbers for your specific situation, weigh the emotional and psychological factors, and choose the path aligned with your financial priorities and risk tolerance. Seek input from financial advisors to ensure you fully understand the implications before deciding.
While being mortgage-free sounds dreamy, it isn’t necessarily the optimal choice for everyone. But nor is carrying debt the universally right strategy. Find the solution that offers you the best financial advantage and peace of mind. With prudent planning, you can put yourself in a strong position to achieve your money goals whether you choose to be debt-free or maintain a strategic mortgage.
Behind the Scenes: What Credit Card Debt Really Costs You
When you want that new top-of-the-line flat-screen TV, it’s easy to whip out the plastic and figure you’ll pay it off over time. But when you stop to calculate what that single purchase can cost you if you don’t pay it off right away, the numbers could make you think again before you buy. Here are three eye-opening scenarios:
Cost of TV: $5,000; interest rate: 14%
- Make the minimum payment each month (usually interest plus 1%) and it will take you 264 months (22 years!) to pay it off. During that time you’ll pay $5,333.30 in interest, more than doubling the original cost of the TV.
- Make a fixed monthly payment of $200 and it will take you 30 months to pay if off with $946.23 in interest.
- Up your monthly payment to $500 and you’ll have your TV paid off in 11 months and pay only $348.12 in interest.
Of course the best scenario of all is to pay cash to avoid any interest charges. The numbers speak for themselves!
Don’t Let Debt Payments Derail Your Savings
Paying down debt and saving for retirement doesn’t have to be an either/or proposition. The two can work together. Once again, you have to prioritize. Here’s what I recommend:
- Save enough in your retirement accounts to capture the entire employer match.
- Pay off high-interest consumer debt.
- Create an emergency fund to cover necessary expenses for a minimum of three to six months.
- Save more for retirement.
After that, prioritize other savings and debt reduction goals according to your own situation.
Should You Pay Off Debt Or Invest? | Financial Advisor Explains
FAQ
Does having no debt help with a mortgage?
While debt isn’t necessarily viewed negatively on a loan application, you’ll want to ensure your total debt doesn’t exceed a certain percentage of your income. Having a DTI ratio of 35% or less is a good rule of thumb.
Do most millionaires pay off their mortgage?
In fact, the average millionaire pays off their house in just 10.2 years. But even though you’re dead set on ditching your mortgage ahead of schedule, you probably have one major question on your mind: How do I pay off my mortgage faster?
At what age should you be debt free?
“Shark Tank investor Kevin O’Leary has said the ideal age to be debt-free is 45, especially if you want to retire by age 60.Feb 25, 2024
Is it best to be debt free when buying a house?
Mortgage lenders want to see a debt-to-income (DTI) ratio of 43% or less. Anything above that could lead to the rejection of your application.