Pay off the mortgage or save for retirement? Three ways to decide.

The relative benefits of paying off a mortgage versus saving for retirement can be hard to assess. It’s important to consider your individual situation. 

The idea of paying off the mortgage — usually our largest source of debt — is appealing to many homeowners. But is it really the best financial strategy?

The relative benefits of paying off a mortgage versus saving for retirement can be hard to assess. It’s important to consider your individual situation. Are you close to retirement age, or many years away? Do you have significant retirement savings? What tax bracket are you in, and how much benefit do you receive from a mortgage interest deduction? Will the returns on your retirement investments exceed what you’re paying for the mortgage?

You may feel dizzy contemplating the range of factors affecting this decision, but the following considerations will help steer you in the right direction.

Paying off the mortgage by retirement

When planning for a secure retirement, consider the benefits of owning a home debt-free before you retire. Say that at your current rate you’ll need $100,000 per year for expenses — including your mortgage — after you retire. If you pay off your mortgage before you retire, you might only need $80,000 each year. An annual $20,000 reduction over a 25 to 30-year retirement adds up to significant savings.

The drawback: You might be in a high tax bracket when you retire, and paying off your mortgage would disqualify you for a mortgage interest deduction. These deductions can range from a few hundred dollars to several thousand dollars a year for some homeowners. But if you’re five to eight years away from paying off your mortgage, you won’t receive much benefit from the deduction anyway.

If you plan to retire in 15 years or less

If you’re late in your career and can make extra mortgage payments, should you? The answer depends on how much you have saved for retirement and your tax bracket.

Retirement accounts are an additional source of income in retirement. Your house most likely won’t be a source of income if you plan to live in it. If you haven’t saved much, you’re better off socking away the money in a retirement account, not only as a way to boost your post-retirement income, but also to lower your taxable income. If you’ve saved a lot and are in a high tax bracket, there may still be tax advantages to keeping the mortgage.

If you’re more than 15 years from retirement

Those in the early or mid stages of their career who can apply extra income to paying down the mortgage may find the idea attractive. While being debt-free is appealing, it may not make the most sense from a financial perspective. Tying up your money in the house won’t provide the income your retirement account will.

If you’re in a higher tax bracket, you may benefit from the mortgage deduction. If you have a low interest rate mortgage, you can probably earn a higher return by investing in tax-deferred accounts, such as a 401(k), than you would by paying off the mortgage.

To summarize

In some cases, you can reduce your annual retirement spending by at least $10,000 by paying off the mortgage beforehand. But if you’re close to retirement and haven’t saved a substantial amount, it doesn’t make sense to pay off the mortgage. You need to fund tax-deferred accounts to create a supplementary source of income in retirement.

People in the early stages or midpoint of their career should also focus on building their retirement accounts instead of paying their house off. Money invested in retirement accounts early has more time to grow and may provide a better return than paying off a low-rate mortgage.

Each situation is unique. The framework above provides generalizations that may not apply to you. You must consider your tax bracket, whether or not you benefit from the mortgage interest deduction and the likely returns on your retirement investments. If the math gets too complicated, seek professional help.

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