Welcome to the Ready Set Retirement Blog, my name is Derrick Glencer I am a CERTIFIED FINANCIAL PLANNER™ Practitioner. The Ready, Set…Retirement Blog focuses on the financial planning questions and concerns of Gen X Execs and Soon to Be Retirees.

In todays blog we are going to explore when It pays to have a mortgage in retirement—and when It doesn’t.

Due to Rising interest rates for retirees who bought or refinanced homes later in life the decision to pay off the mortgage prior to your retirement is not as straightforward of a decision, primarily because the math has now changed.

Those who can afford to pay off their mortgages might find there is now a case for keeping their loans in retirement. Thanks to higher interest rates, investing savings in bonds instead of paying down principal could return enough to cover more than the cost of the monthly mortgage interest.

Americans now are much more likely to carry mortgage debt into retirement than prior generations. According to the Federal Reserve, nearly 38% of those ages 65 to 74 had mortgages or home-equity lines of credit on a primary residence in 2019, the latest year for which data is available. That is up from 22% in 1989.

When interest rates were low, many homeowners refinanced into new 30-year loans. For many older borrowers, those refis have extended loan terms far into retirement.

Many retirees cannot afford to pay off their mortgage in a lump sum or feel they are better off giving priority to other goals. Lots of people prefer keeping an extra cash cushion in a bank or a brokerage account, rather than using it to pay off a mortgage, since home equity can be difficult and expensive to tap in emergencies.

For those with the capacity to pay off a mortgage, here are factors to consider:

Two rates to compare

If you can afford to pay off your mortgage now, the key calculation is to compare your mortgage rate with the yield on an ultra-low-risk investment, such as a Treasury note or bond. The goal is to see if you can earn enough in interest after taxes to cover your continued mortgage interest.

Consider someone with a $100,000 mortgage that charges a 3% interest rate. By paying off that mortgage, the homeowner would save 3% a year, earning a guaranteed 3% return.

That person could also use the $100,000 to buy a short-term Treasury note, which would bring a slightly higher guaranteed return of about 3.49% in interest.

What about investing the $100,000 in stocks to aim for an even higher return to cover your mortgage payments and generate a bigger profit? Since 1926, U.S. stocks have delivered an average annual return of about 7% after inflation, according to Morningstar Inc.—far higher than the interest rate many home borrowers are paying on their mortgages these days.

But that 7% return is far from guaranteed. So far this year, the S&P 500 is down about 16.8% through Sept. 1. And from the end of 1965 to the end of 1981, the annualized return on the S&P 500 was about 1.8% without dividends.

That illustrates the risks of such a strategy.

Consider the tax impact

Taxes can change the math on the decision to pay off a mortgage, generally in favor of paying off the debt.

Since the 2017 tax overhaul, which significantly raised the standard deduction, far fewer homeowners have taken a tax deduction for their home-mortgage interest payments.

Those who do should reduce the cost of their mortgage to reflect that tax benefit when deciding whether to pay off the mortgage.

If the homeowner above with a 3% rate on a $100,000 mortgage receives a home-mortgage interest tax deduction, the cost of that 3% mortgage falls to 2.34% after the tax benefit is factored in. (This assumes the homeowner is in a 22% tax bracket.)

The homeowner must compare the 2.34% after-tax cost of the mortgage with the after-tax return he or she could earn on a Treasury note. Someone in the 22% tax bracket would forfeit 22% of the note’s 3.49% in interest to taxes. That leaves an after-tax return of 2.7%, according to Mr. Roth.

Because the bond’s 2.7% after-tax return exceeds the mortgage’s 2.34% after-tax cost, the strategy of buying bonds to pay the mortgage remains the more profitable choice.

However, if the homeowner doesn’t receive the full tax benefit from taking the deduction, the bond’s 2.7% after-tax return falls short of covering the 3% mortgage. As a result, the taxpayer can get a higher return by paying off the mortgage.

Despite forecasts for a cooling housing market in 2022, U.S. home prices are still hitting record highs, even with mortgage rates surging in recent months. WSJ’s Dion Rabouin explains what’s driving demand, evidence of a slowdown on the horizon, and what that could mean for the economy. Photo composite: Ryan Trefes

How paying off the mortgage can affect liquidity

If you pay off a 3% mortgage only to discover you need to tap your home equity in retirement, you may have regrets.

Retirees with substantial assets but little income can have trouble qualifying for a new mortgage.

Even when the math is favorable, some retirees may still feel more comfortable paying off the loan as soon as possible. Eliminating it can bring peace of mind and a sense of accomplishment.

Again, my name is Derrick Glencer I am a CERTIFIED FINANCIAL PLANNER™ Practitioner and this is the Ready, Set…Retirement Blog If you enjoyed this content you can book a complimentary consultation via Calendly at: https://calendly.com/djgcfp

Or directly through email at: derrick.glencer@raymondjames.com

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Thank you very much and go make it a great day!

The information covered in this podcast represents the views and opinions of the Derrick Glencer and his guests and does not necessarily represent the views or opinions of Raymond James. Raymond James is not affiliated with and does not endorse the opinions or services of any of the quoted professionals or their respective firms. Expressions of opinion are as of this date and are subject to change without notice. Any examples or case studies are for illustrative purposes only. Individual cases will vary. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP^®, CERTIFIED FINANCIAL PLANNER™, CFP^® (Plaque design) and CFP^® (with flame design) in the U.S., which awards to individuals who successfully complete the CFP Board’s Initial and ongoing certification requirements. Diversification does not guarantee a profit nor protect against loss. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.