By Tali Wee of Zillow
Homeowners are frequently curious whether they should save for retirement or pay off their mortgages. The best answer is to both save and pay off debt, but unfortunately one answer doesn't cover all cases. Review these five advantages to paying off a mortgage before entering into retirement.
1. Reduce Retirement Expenses
Most obviously, homeowners preparing for retirement want to minimize their expenses. Monthly mortgage payments typically account for 25 percent of the owner’s pre-retirement income, which is a lofty expense during retirement. Without the burden of mortgage costs, homeowners tend to feel more prepared to retire.
2. Save Costs of Interest
Paying off a mortgage before its 15- or 30-year term saves the homeowner interest costs. Homeowners with high interest rates who are close to paying off their mortgages may not benefit from refinancing because of expensive fees. However, aggressively paying off their mortgages would save these owners interest costs, which could then be applied toward retirement savings. Homeowners with variable rates on their mortgages also could benefit from paying off their loans early by saving on potential hikes in interest rates.
3. Tax Deductible Interest Payments
When homeowners are approaching retirement, they should save money as well as pay off debts. Many homeowners think 401k contributions are more profitable than paying off their mortgages, which may be true if employers match contributions. However, tax deductions may apply for interest payments on mortgages, which also save owners money. Homeowners should balance their current incomes to contribute to their 401ks while paying down their loans.
4. Highest Profit When Downsizing
Often times older homeowners choose to downsize their living quarters because large homes become more difficult to navigate or clean. Downsizing near retirement is common because sellers profit from their sale, applying a portion of the funds toward a smaller property and the remainder to retirement savings. The more equity the owner has in the home, the more profit he or she will receive upon the sale of the home. In other words, if the owner stills owes several thousand dollars on a property, he or she must pay the lender before pocketing the profit; if the home is paid off, the owner has more funds for new residency and retirement.
5. Spend less by paying off the mortgage
Often we mistake wants for needs and misspend our income. Savers who make extra payments to pay off their mortgages earlier increase their potential for a comfortable retirement because they simply spent less during their working years.
Although the general rule is home buyers can afford mortgages worth 25 percent if their incomes, it assumes their incomes don’t decline throughout the 30-year terms of their loans. If home buyers are more aware of their timelines for retirement, they’ll be more informed about the best type of loan for them upon purchase. Just as saving for retirement is a goal all working-aged individuals should strive for, getting out of debt to reduce expenses during retirement is equally important.