In the old days, the issue was straightforward: if you owed money on your home – in other words, if you had a mortgage – you probably believed that you simply had to pay it off before you could retire. But is that assumption still valid? Apparently not.

In fact, as this 2018 AARP report reveals, roughly 44 percent of people between 60 and 70 still have a mortgage. When asked how long before they expect to pay it off, one-third of respondents predicted it would take 8 years or more – and about one respondent in six said they might never pay off their home in their lifetime. What a change from the past when retiring without debt was the goal of most seniors.

But is paying off your mortgage essential for a secure retirement? According to this recent article from the Kiplinger website, written by certified financial planner Evan Beach, the issue isn’t as simple as it sounds. According to Beach, the key question is, “If you’re planning on paying off your mortgage, where will you get the funds to do it?” Let’s see if what Beach has to say makes sense.

So-Called Experts Give Conflicting Advice

In his Kiplinger article, Beach uses a familiar experience – the radio talk-show – to explain how self-styled financial “experts” can give conflicting advice on the mortgage pay-off question.

“It’s 5 p.m. on a Tuesday,” he writes, “and you tune in to The Ramsey Show as you sit in gridlocked traffic.  Dave Ramsey is going on about the best ways to pay down debt and why it’s imperative to be debt-free.” In Beach’s imaginary example, he adds, “You have two things working in your favor: (1) You have the money to do just that.  (2) You only have to commute in rush-hour traffic for a few weeks longer, as you will retire at the end of the month.”

But then you hear the other side of the issue. “The next day,” Beach goes on, “you start to do some research on paying off your mortgage, and you come across Ric Edelman, the founder of one of the largest personal finance companies in the country.  His advice is just the opposite of Ramsey’s:  You should stretch out a big mortgage for as long as possible, he maintains.”  

The Answer May Depend on Which Group You’re In

Beach acknowledges the conundrum facing the average mortgage holder. “I’m guessing this leaves you a bit confused,” he writes.  But in fact, there’s often no single correct answer. “The truth is that personal finance is just that: personal.  The right answer for you won’t come from someone speaking to a million people and giving one answer.”

Beach’s point is that the decision on when – or if – to pay off your mortgage may come down to a simple question: where will the pay-off money come from? “If you have the money necessary to pay off your mortgage and you are retired, or nearly retired,” says Beach, “this article will allow you to place yourself in one of three groups, to get closer to the right answer for you.” 

Group #1: You Have the Cash Readily Available

In Beach’s description, “Group 1” consists of those who are worried about market volatility, so they have cash readily available to pay off their home loan. “Should you pay your mortgage off?” he asks rhetorically. “Yes. In this case you should pay it off.”

In his Kiplinger article, Beach explains his reasoning, using the financial term arbitrage. “Applied in this context,” he writes, “you have negative arbitrage.  The bank is paying you 0.25 percent on your savings account (if you’re lucky) and charging you 3.75 percent on your mortgage.  So, you are losing 3.5 percent every year you hang on to that loan.  This is oversimplifying, of course, but you get the idea.”

What’s the downside for Group 1 people of paying the mortgage off, Beach asks? “First and foremost, you are losing liquidity.  When you pay off a mortgage, you are essentially putting money into a piggy bank that you can’t get back out unless you sell the home or tap the equity.  Second is the tax consideration.  Paying off your mortgage may mean that you fall below the standard deduction threshold because you don’t have the mortgage interest to write off.  This could raise your effective tax rate, but likely not significantly.”

The final point in favor of keeping that mortgage, says Beach, is “especially relevant” in today’s economy: keeping that loan serves as a hedge against inflation.  As the cost of living goes up, you’re fixed-rate principal-plus-interest payment stays flat. This can balance out the higher prices you’ll be paying for just about everything else. 

Group #2: You Have the Funds in a Brokerage/Taxable Account

In Beach’s view, the dollars parked in a brokerage account should stay there. For those in “Group #2,” his answer to the question, “Should you pay your mortgage off?” is “Probably not.” For Beach, it’s all about comparative interest rates.

“You now (historically) have positive arbitrage,” he explains. “From 1991 to 2020, the S&P 500 returned 10.72 percent on average, annually.” While the old saying is true – “past performance is not indicative of future results” – the fact remains that paying off a 3.5 percent mortgage with dollars earning three times that much is a costly decision.  Moreover, this doesn’t take into account the possibility of hefty capital gains taxes on the investments you cash in to pay off your home.  “Depending on your taxable income and the size of the gain, you are likely to pay 15 percent or more of that gain to the Treasury before you pay off that loan,” Beach warns.   

Again, there’s always another side to the coin. If you do pay off the mortgage, you’re protected against a highly volatile stock market, especially these days. “Historically, stocks go up about three-quarters of the time,” Beach acknowledges. “In order for you to make money by earning more than the interest rate on the loan, you have to be in that 75 percent.” Still, Beach is bullish on the market over the long haul. While “no one has a crystal ball,” he writes, “My feeling is that you have to bet the odds that the market usually goes up, and [it] usually goes up by more than the current mortgage rates.”

Group #3: You Have the Funds in a Retirement Account

Beach’s answer to the pay-off question for those in “Group 3” – people with cash in a pre-tax retirement account – is unambiguous. “Should you pay your mortgage off? No. You shouldn’t pay it off in this case.” Here it’s all about taxes.

“I get this question all the time,” he writes, “but no one has ever asked me after actually cashing out a retirement account to pay off their mortgage.  My guess is that the accompanying tax bill affirmed that it was a bad decision.”  The issue is that pulling funds from a pre-tax retirement account means your taxable income goes up by the same amount. “Therefore, if you take a large withdrawal, your bracket will jump, and you will see a significantly smaller amount come into your bank account before you pay off your loan,” Beach states. This can come as a harsh surprise for someone unprepared for the tax hit.

“There is comfort in living debt-free in retirement,” Beach writes. “Having a lower housing expense provides you more flexibility in your discretionary spending.  But, in this case, is it worth the cost?” In his estimation, the answer is no.

Is There One Right Answer?

“Neither Dave Ramsey nor Ric Edelman is wrong,” Beach concludes. “They just give different reasons for their advice.  Ramsey uses mostly behavioral reasoning.  Essentially, he believes that people are not going to use discretionary income beyond their 30-year mortgage payment to invest, but rather to buy things they don’t need. Edelman’s reasoning is purely mathematical.  He does not hypothesize about what people will do with excess income but points out that if you can earn more in an investment account than what you pay in mortgage interest, you come out on top.”

The answer that’s right for you, it would seem, is highly personal. “The challenge for all of these talking heads is that they don’t know who they’re speaking to,” says Beach. “Everyone has a money script.  If your parents lived through the Depression and drilled lessons into you about the evils of borrowing money, you probably don’t care about the math behind my reasoning.” In other words, there are many for whom the security of having a paid-off house transcends all the interest rate arguments any “expert” can make. After all, no one can predict the emotions behind your decisions

We really like Beach’s final statement. “Here’s the good news,” he concludes: “I’ve yet to find someone who regrets not having a mortgage in retirement.” Amen to that. 

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(originally reported at www.kiplinger.com)