Should You Pay Off Your Mortgage Before You Retire?

MARK RIEPE: Over the past couple of years, the defining feature of the U.S. economy and financial system has been the dramatic rise in inflation and the attempts by the Federal Reserve to fight that inflation by rapidly raising interest rates.

Those interest rate increases have had a profound impact on debtors (in other words, those who owe money) because the cost of debt is much higher than it used to be. It's an especially important development for a certain type of debtor—those who have a mortgage on their home but who are approaching retirement.

Should they pay off the mortgage or continue to make their normal payments of interest and principal each month?

I'm Mark Riepe. I head up the Schwab Center for Financial Research, and this is Financial Decoder. It's a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.

Let me give you some context on the enormity of this decision.

According to the Federal Reserve, Americans aged 60 years and older owe $4.02 trillion dollars as of the second quarter of 2023.[1]

And $2.95 trillion of that is in the form of mortgages.

That's a big number, and decisions about big money are prone to induce some anxiety, but decisions involving debt can be even more emotional.

For some, carrying debt is worth it because it enables spending and a way of life that wouldn't be possible otherwise.

For others, debt is a load on their back, and they can't wait to be free of it.

For older individuals who are contemplating retirement, that's another emotional decision, and so throwing a mortgage into the mix can be an emotional double whammy.

To help sort this out, I'm happy to welcome back to the podcast Rob Williams. Rob is the managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research.

He's a CERTIFIED FINANCIAL PLANNER™, Retirement Income Certified Professional®, and a Certified Wealth Advisor. He's been quoted in the financial media including The Wall Street Journal, MoneyWatch, Kiplinger's, U.S. News & World Report, Investor's Business Daily, and other publications.

Rob, thanks for coming by today.

ROB WILLIAMS: Hi, Mark. It's great to be here.

MARK: Rob, for most people, buying a home, you know, probably the biggest purchase they'll ever make. But if you have a mortgage on it, it's also a liability. And so the decision we're focused on is whether it makes sense to pay off the mortgage before you retire. And I've got a few reasons here why you might want to do that, and I'd love to get your feedback on those. So the first up is just to cut down on your baseline expenses. Because if you pay it off, you know, that interest payment, that principal payment, they both go away.

ROB: Yeah, I agree. That's the obvious place to start. If you pay off the liability on your mortgage and the home, your monthly mortgage payment's going to go away and you're … have a lot more money to spend on other things once you don't have that payment. This can be particularly helpful if you've retired and you don't have an income anymore, obviously. There'll still be housing expenses—you'll have property taxes, maintenance, and things like that. But a big goal for a lot of retirees, we hear and think this makes sense, is to try to get to the point where you've paid off that mortgage and it goes away.

Now there's a lot of other factors that go into this, and that's really important, and I know we'll talk about them. But lower expenses, that's definitely the first bonus that most people think about.

MARK: We've talked on previous episodes about the importance of taking a broad frame when making decisions and not just making that decision completely in isolation, but really thinking about how it affects the other aspects of your financial life. And in the case of a mortgage, if you pay it off, that costs money, and that money could have been used for other things. So how does that affect the decision to make that prepayment or that early payment of the mortgage?

ROB: Well, I think there are two sides to any financial decision. There's an emotional side and there's a financial side. The financial one we already started, and that is if you don't have that mortgage payment, you've got assets, you've got income, you've got money you can use to invest to spend on lifestyle goals, your retirement, et cetera. So having a plan to get to the point where your mortgage is at least close to being paid off when you retire has a financial benefit.

The other, emotional side is the satisfaction of having done so. And having that … what was a liability now is an asset. You have a home. Hopefully it continues to appreciate. It's something you live in, and the emotional side of it.

So like you said, there's a broad frame when looking at these decisions. There's one emotional, one financial. It's really important to keep both in mind.

MARK: Rob, I want to go back to something you said about the emotional component of this. It's not just purely a financial thing. If you're debt free, it seems to me that that's a big emotional lift, not having that debt hanging over you. So do you agree, and how do you factor that into the decision?

ROB: Yes, totally. I agree that paying off a mortgage is the emotional side of feeling like you've gotten that liability paid off. You have the home to live in, and it's no longer something that you have to budget and spend for. Now clearly there's other things you're going to be paying. You have property taxes and things like that. But that mortgage has gone away.

And assess those emotions. You can ask, "Would you feel better or more in control if you paid off your mortgage?" I think most people would say, "Yes. I'd feel a lot better after retiring and having that payment go away." This is important along with the math alone. So, you know, it's not just this decision, "Well, hey, I could invest the money. Maybe I could do better."

It doesn't have to be either/or either. You could pay off a portion of the mortgage, but not all of it. So you're speeding up the payment of that mortgage and getting rid of it and moving more quickly and towards that emotional comfort level of having the payment go away. You know, as I said, this is part of the broad frame you described. The answer isn't always yes or no. It can be a bit of both the emotional side and the math as well.

MARK: Let's assume for the moment that you make that decision to pay it off. What's the smart way of going about doing that?

ROB: Well there's a few ways. I mentioned a couple. One is simply you can increase your payments each month and ask the mortgage company to use the extra amount to steadily pay down your mortgage balance faster than it was scheduled. Anyone has that option, and you can plan this ahead. So you can do that over a period of years. That's not a lump sum at one point in time, but you're speeding up the payoff of the mortgage gradually. And you can even plan that to line up roughly with the year you plan to retire or thereabout. So five, six years ahead of time to do it gradually. This can save a significant amount of interest, and it shortens the life of the loan. So the amount of interest you're paying decreases and when you pay it off, speeds up. And you can also not pay it off in a lump sum. You're maintaining, you know, goals to invest as well.

So the second really is a lump sum. So use money you have set aside and simply just pay off the mortgage in full. And if you do that, your mortgage goes away, future payments stop. And it's really critical to know though that there's a balance here. You don't want to suddenly be cash poor because you've paid off the mortgage. If you have other expenses and things coming up, it's important to have money handy and ready. And so the balance of those things is important.

You know, choosing between the two of those—really helpful always to have a plan where you can do both of them. I really like the idea of paying it down gradually over time and factoring that into your retirement planning, you know, well in advance of your retirement date. That's really the first strategy and can be very helpful.

MARK: Yeah, within the broader topic of, let's say, retirement planning, you've talked many times about the importance of having a certain amount of liquidity. And if you're making these early payments, or in the case of a lump sum, making a large payment, your liquidity is going to go way down. So is there a baseline level of liquidity that you want to maintain, and it's not worth going below that liquidity just to pay off the mortgage?

ROB: Yeah, there's an emergency fund that we generally suggest for someone who's prior to retirement that's about three to six months of what you're spending. In retirement, this becomes a lot more important, and I'd really increase that—what we call the liquidity amount—the amount you have easy access to at a relatively predictable price, meaning it's not going to move up and down dramatically like a stock. Increase that to really two to four years of your expenditures. You don't have a paycheck anymore. You may have Social Security. You may have other things. But if an emergency comes up, or you're living off of your portfolio and the market's down, two to four years of those liquid sort of cash investments and things like that is a really good thing to have, rule of thumb. So if paying a lump sum involves you getting down below that level as you're moving into retirement, I'd say maybe hold back a little bit. But you know, Mark, that two to four years is really nice to have to be able to get through any market downturn and not have to panic and sell investments.

MARK: Rob, retirement—that's the number one goal for most people when saving and investing. And let's say they're approaching retirement and their savings, their investments, that balance isn't where they hoped it would be. Is it better to reduce that savings further and pay off the mortgage or to keep saving and investing in the hopes of generating a bigger balance? You kind of alluded to this earlier in the first question. So maybe can you go into a little bit more detail about how to make that … how to make that tradeoff?

ROB: Yeah, there's a lot of things where it's sort of, you would say, it depends on the client's preferences or the investor's preferences if you're a person making this decision on your own. In this case, I wouldn't say that as much. I suggest that they keep saving. In every mortgage payment, you're already paying down a portion of the principal on that mortgage. And if you keep doing that, you know, ideally, you're ultimately going to pay off the mortgage. And so the really important thing is to make sure that you keep saving, have that both liquidity that we said, two to four years available, as well as investments for the long duration of your retirement and treating that like a monthly contribution or an expense. If you aren't doing that, I would do that first. So saving for retirement if you're behind—I would generally prioritize over taking some of that money to pay off the mortgage. Certainly there are exceptions, but I think that's probably a good starting point for most. You want to make sure you have enough savings for retirement. That debt you can pay back over time.

MARK: One point of clarification is that the vast majority of mortgage payments include money allocated for interest on the mortgage as well as money allocated toward principal. In other words, when you make your payment, it's kind of like being divided up into two pieces. However, there are some mortgages known as interest-only mortgages where your monthly payment just covers the interest. But those are relatively rare.

More importantly, Rob, though, is the question of how do you go about investing the money so that you can achieve that retirement dream?

ROB: Yeah, I mean, the common answer is to say, well, get the right portfolio for your risk tolerance, your time horizon. You certainly have talked about that on many other podcasts, and I think that still applies. I like to think backwards for those working into retirement and say, let's make sure we're starting to build up that two to four year, what I call the kind of short-term reserve, the money you need for the next two to four years. You're starting to create a budget that's a little bit more realistic and based on your actual spending. As you're getting close to retirement, that becomes really important. Do that even if it means sort of changing some of the investments in your retirement portfolio you already have

After that—disciplined investing, diversification, knowing that your retirement may last 20 years or longer still applies here. So creating a diversified portfolio. I see a lot of people who are behind, and they are saving and they say, "Well I want to buy stock X, Y or Z." They kind of swing for the fences. That may work for some, but there's a lot of risk there. So if you are catching up and you're investing, continue to do so in a diversified way—stocks, bonds, cash, all of those together. Again, your retirement is maybe one day, but it's going to last a long time. So a diversified portfolio makes sense.

MARK: Rob, most people have multiple forms of debt that they're carrying. We've been talking about mortgages, but there's car loans, there's credit card loans, potentially there's student debt. So where does paying off the mortgage kind of appear in that hierarchy of importance compared to reducing other forms of debt?

ROB: It ranks pretty low for me. It's still important, but you kicked off this podcast by talking about assets and liabilities. And the unique aspect of a mortgage is it's usually used to purchase an asset. A home is an asset; it doesn't have to appreciate in value, but they generally do. That's not true, say, of buying a car and certainly not true of using your credit card to go to the mall and buy a bunch of new clothing, things like that. So anyone should really pay off high-interest-rate credit card debt first. That's like the one thing that if you carry a credit card balance, pay that off—that debt—before you pay off anything else. The interest rates are very high. It's usually for discretionary things that you're paying for that maybe you're spending a little bit more than you need. So getting down to that discipline of not carrying a balance on your credit card—that's the first liability I would pay off.

And then you can move on to other types of debt that might not be tax deductible. There's definitely been limits on how much you can deduct of interest payments on mortgages over the last few years, but some of it still can be and is tax deductible. So things like car loans, perhaps a home equity loan—if you have one of those—you might pay those off next. And then the mortgage, generally for me, comes last on the list. It's nice to do. It's emotionally very satisfying to own your home, but I'd pay off those other types of debt first if you had to choose.

MARK: Rob, interest rates are high right now, at least as of the time we're recording this, but most people actually have existing mortgages that have relatively low rates locked in. So how does that affect the decision to pay off or prepay a mortgage or not?

ROB: Well, having a low interest rate on your mortgage right now is great. And we've been talking about, for many years, when mortgage rates were low to refinance and lock in that low rate. So if you got it, that's a huge asset. That's a benefit. You could go out in the market today and buy a CD or a Treasury bond and get returns, you know, 4 or 5 percent potentially. And that's much higher than, you know, mortgage rate in the 3 to 4 percent. That will change your thinking a lot. If you have a low mortgage rate right now, that may help you lean a little bit more towards—let's keep making those payments. Maybe accelerate the payments, but paying it off all at once, there's an opportunity cost. You could be using that money to invest potentially in relatively safe places and be earning a higher return. So that does affect the decision, I think, that you would be making on whether to repay.

MARK: Rob, we're recording this in September of 2023. Many people, many market participants, are expecting the Fed to start cutting rates in 2024. That'll filter through to the mortgage market. So let's assume rates start coming down. How does that affect the decision?

ROB: Well, it hasn't happened yet. And mortgage rates do tend to go with interest rates, but not lockstep with the short-term interest rate. There's lots of different interest rates in the market. Mortgage rates are one. They tend to move with other parts of what we call the yield curve, the 10-year mortgage rate, et cetera. So I wouldn't count on mortgage rates falling dramatically, at least not in the next year or so. We'll see. But if you have a low rate right now, I would keep it. If you have an adjustable rate, that's something that you may want to think about accelerating, but waiting for rates to go down, thinking you'll refinance again, maybe not the best path, even if they do, you know, actually do that in the next couple of years.

MARK: Rob, mortgages typically come in two varieties. You've got your fixed-rate versions, and you've got your adjustable-rate versions. So has anything we've been talking about in terms of this prepayment decision—is that affected by whether you have a fixed or adjustable rate? Some people call it a floating rate.

ROB: Yeah, I think so. The sense of interest rates on mortgages, if you've been watching mortgage markets or even just interest rates in the bond market, rates have gone up. And so if you have an adjustable-rate mortgage—if your rate hasn't already risen, it probably will soon when the date comes for it to do so. So I would prioritize trying to accelerate or try to pay off more quickly, either through those monthly payments or through a lump sum if you do have an adjustable-rate mortgage. There's risk to it. Rates are higher than they were, and there's less of the benefit of having a low fixed rate in place that you might want to keep. So that does change the thinking if you have an adjustable-rate mortgage at this time.

MARK: Rob, earlier you were talking about either—if you're going to kind of pay off the mortgage earlier either through a lump sum or just through accelerated payments, that is certainly one way of a couple ways of getting that done. Are there some mortgages that don't allow people to pay them off early? And if so, what are some of the rules around that?

ROB: Most allow it. There certainly are some that have early payment penalties, but that's a really great thing to know and to ask. It's not particularly common to have that, but there definitely may be some limitations, especially if you just refinanced or if you just purchased the home. If you've had a loan in place for … a mortgage in place for a number of years, generally, they're going to allow those early payments. And like anything, read the rules, understand that, and make sure you know if they are. But for most, there definitely aren't, whether it's a lump sum payment or that strategy of making monthly payments that are higher than your payment and having a portion go to pay down the principal more quickly, there may be more limitations on that, but the best thing is just to ask.

MARK: Rob, you mentioned that after you pay the mortgage, it's not as if all your expenses associated with that home go away. So could you just quickly enumerate what those are?

ROB: Right. The mortgage is generally the principal and interest is for the liability, for the debt. But you may also be escrowing and paying in your monthly payment. Your bank is collecting insurance payments as well as property tax payments, and they're paying those for you. So that can be part of the monthly payment as well. Not for everyone, but for many, that is part of the payment. So those won't go away, that'll continue. So it's really important that you're paying off the debt, but you still have those other expenses, and if your bank has been paying for you, make sure you're accounting for that and that you're going to be paying those, going forward, yourself.

MARK: Rob, I wanted to go off topic a little bit and talk quickly about reverse mortgages. Before the 2008 financial crisis, these were achieving a degree of popularity, and then they kind of dropped off the radar. But lately, I've been seeing a lot more commercials for them. So what are your thoughts on these?

ROB: There are a lot of things that have changed with reverse mortgages. I do think they can be a very helpful tool if chosen well. There's been a lot more regulation around them, and some are actually sponsored and provided by federal government programs. So it's definitely an interesting area to watch and to look at in terms of an ability to tap equity for older folks in their homes without having to leave. And I do think that can be a useful tool.

There are a couple strategies people can learn about and use. Some offer access to your equity if you have an emergency or a healthcare expense. Or say your portfolio is down, and you don't want to sell some stocks, that can be used as a bit of an emergency source for funds. There are other types of reverse mortgages where you can choose to just get a basically, an income payment, a payment each month that can offset a portion of withdrawals from your portfolio. If you have it, it can supplement Social Security.

Now these can be complex. That goes back to the point before. So it's really important to understand the details. A commercial is a nice trigger to learn more, but just make sure you're working with a really trusted professional, a financial planner who can help look at this in the context of your whole plan. So they're neither good or bad. They're tools. I think they've become better tools, and I think a good planner, you know, can often help you work through the details.

MARK: Rob, people who are planning on leaving their home to their children or maybe other family members, if you're in that situation, is it better to leave them a home that's fully paid off, or does it matter if the home still has a mortgage on it when they inherit it?

ROB: I guess it depends on who you ask. I'm sure the heir would love to have a fully paid-off home. But beyond that … you know, I do think there are some important things to consider. One is, generally speaking, when ownership of a home changes, the mortgage may come due. So if there is a mortgage coming due, it's important for that … the heir to have the cash available or in your estate plan for you to have accounted, you know, for providing cash to them to do so. Otherwise, you can get into some issues and trouble with, you know, not being able to finance. That's especially true if you have a very low mortgage rate now, and your heir may have to refinance at a higher rate if there is a mortgage. So paying it off generally—yeah, if you have the money, you know, can make a lot of sense. And make sure you talk to your children or family members. Again, I'll always say talk to a planner, an estate planning specialist as well, if you're concerned. There are a lot of moving parts here that move … that can work together. But generally speaking—yes, paying it off certainly can make things easier than otherwise.

MARK: Rob, I wanted to go back to something you said earlier. We've kind of been talking about this—as in framing the decision here as kind of this either/or—pay it off, pay off the mortgage, or don't pay it off. And you alluded to, well, it doesn't have to be black or white. You can do it partially by just kind of accelerating payments. So how do you figure out where that middle ground is?

ROB: Yeah, I mean, I think our brain sometimes goes to this all-or-nothing decision. You know, "Should I buy stocks? Should I buy bonds? Should I pay off my mortgage? Should I not?" I think it's really useful here and in so many areas to say "Yes, and you can do both." So it's a middle ground, and to do it over time, plan ahead. So having more payments, a larger payment over a period of years that goes to pay down the principal on the mortgage, while continuing to save, balances the best of both. Paying one lump sum all at once or not doing so—that's the dramatic extreme decision. Finance is about balancing all these things, and a plan helps you do it. So the middle ground is probably the best approach here for most. Now there's exceptions. If you have a large, you know, retirement portfolio. You just want to pay it off. You have the money, just pay it off in a lump sum. Great. You're very fortunate to have that decision you can make. For most of us, balancing the two and balancing all of our goals and priorities is going to be the best path to success.

MARK: I think another—and maybe this is a good place to end it—another balancing act that people have to do when investing is always this, as you alluded to it, kind of the quantitative part of this decision versus the emotional decision. And I don't think there's any asset that we own is probably more emotional than our home. It's kind of our castle, right? So what's your take on how people can kind of balance the emotions of the decision versus the practical matters?

ROB: There really isn't anything probably more that we attach significance to—I would think, especially in my experience, talking with so many investors that are aging, parents, et cetera—than where they live. Investing is emotional, sure, but where you live and what you've worked to pay off a home, that's a powerful, emotional thing. And the more we can accept and look at our finances as being more than just the money, but about these factors of what the money does for you, and the home is one of them. It is a very emotional possession and has history and memories. So paying it off and not having that mortgage payment anymore, we started off saying this. There's a math part of it, and we can make good mathematical decisions. But there's also the planning that goes into "How do you want to live in retirement? Do you want to own your home?" And then if you do, you need to plan for it and to be making those payments over time. I'll end too with—it is an asset. Your home is an asset. And if you are … many people may be moving on to downsizing and other things. That is a very big part of many people's financial plans, their retirement plans, is that home. So paying it off is going to give you the flexibility to have a lot more choices about how you live and where you live and how you fund that retirement than if you don't. So planning ahead for that really is a very important part of retirement planning in our view. And I'm glad that you've raised this point about the emotions and the math going together.

MARK: Rob Williams is a managing director for financial planning, retirement income, and wealth management here at the Schwab Center for Financial Research. Rob, thanks for being here today.

ROB: Thank you.

MARK: Mortgages are complicated, but getting the mortgage decision right matters because the dollars at stake are substantial.

To help you with that you can learn more by checking out an article on Schwab.com/Learn called "Should You Pay Off a Mortgage Before Retiring?"

Of course, there's more to the retirement process than just the decision about a mortgage, and so after you've read that article, you can scroll to the bottom of the page to a link labeled "Explore more topics" and then click "Retirement."

You can also find this in our show notes.

This is the first episode of a new season for Financial Decoder, and we'd thought we'd try something different.

We're adding a new segment called "What's New?" We're going to use this segment to give you a snapshot of a recent study or insight that we think you'll find interesting.

The football season is underway, and that was the inspiration for a recently published study from scholars at UCLA.[2]  The goal of the study was to see whether visual perception could be affected by cognition. To be more specific, it examines how our perceptions of what we see are affected by what we have learned through experience.

Here's where football comes in. The study examined whether people associate lower jersey numbers with player size. In other words, is it the case that players with lower numbers on their jerseys are perceived to be more slender than players with higher numbers.

It turns out that many football players believe this to be true according to an ESPN survey.[3] And some players even go so far as to select lower numbers if they want to be perceived as being faster and more agile.

In the study, participants were shown computer-generated images of football players whose body type was the same, but crucially, had randomly selected numbers on their jerseys. The study participants were shown the images of the players one at a time and then asked to rate each player on their slenderness versus huskiness.

The result was that players wearing lower numbers were, in fact, more often rated as being more slender—even though they were the same size as players with larger numbers.

What appears to be happening is that, over time, our brains learn to associate high numbers with large size. For example, a 20-pound bag of flour is larger than a five-pound bag. And this unconscious expectation shapes our perception. It's a case of judging a book by its cover—or a player by his number. But first impressions can be wrong.

A finding like this has a lot of relevance for financial decisions, and we've had many episodes where we've encouraged people to dig deeper because of this fault in our perceptions.  For example, when faced with a financial decision, you're often presented with a default choice.

But the default option isn't always the best choice for you given your situation. Is the "automatic" investment selection for your 401(k) plan right for you?  It's an easy decision to make, and maybe it's more prominent than other choices. Maybe it is best. But maybe not. A deeper dive could make a big difference in your retirement savings.

Here's another example. Right now, bonds are an investment being looked at by more investors because yields are so high. But is the bond with the highest yield the best bond for you? Maybe, but probably not. It isn't an accident that a bond has a higher yield than others. That higher yield is an enticement to get you to buy it because it has some other undesirable characteristic that usually means it's riskier.

One more example. What if you're in the market to buy a mutual fund? One of the first things that investors tend to look at is recent performance, but the correlation between recent performance and future performance is slender indeed.

The bottom line is that it's incredibly easy to make snap judgments when it comes to your financial life. Snap judgments that may seem correct, but often aren't. Your financial life is too important, so take extra time to dig at least a few inches beneath the surface and make a more informed choice. And if you don't have the time, expertise, or interest to do so, then look for an advisor who can help you out.

Finally, we've got an episode coming up on Financial Decoder where we'll dive into our pre-retirement checklist. We'll get into the nuts and bolts of how to prepare to retire in the months and years before you claim that gold watch.

That's it for today. To hear more from me, you can follow me on my LinkedIn page, or on X, the social media platform formerly known as Twitter.

If you've enjoyed the show, please leave us a rating or review on Apple Podcasts.

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Thanks for listening.

[1] Federal Reserve Bank of New York Research and Statistics Group, Quarterly Report on Household Debt and Credit, 2023: Q2 (released August 2023).

[2] Leon T. Shams, Alisha Fory, Achint Sharma, and Ladan Sharma, "Big number, big body: Jersey numbers alter body size perception," PLOS One, September 7, 2023, https://doi.org/10.1371/journal.pone.0287474

[3] Seifert, K. (2019, 12 05). Behind the wide receivers' numbers shift: Why the NFL's best are donning Nos. 10-19. ESPN. https://www.espn.com/nfl/story/_/id/28224466/behind-wide-receivers-numbers-shift-why-nfl-best-donning-nos-10-19.