Should You Pay Off Your Mortgage or Save for Retirement First?

You’ve finally saved up enough money to fill your emergency fund and you’ve paid off your high-interest rate consumer debt.

Now you’re trying to figure out what your next financial step should be.

Financial experts often suggest investing 15% of your household income in Roth IRAs and pre-tax retirement accounts.

Others advocate different strategies such as investing as much as you can so you can retire early or paying off your mortgage as fast as possible before investing for retirement.

But how do you know if saving for retirement or paying off your mortgage early is the right move for you?

Here are a few things you should consider about paying off your mortgage and saving for retirement before you decide which is right for you.

Paying Off the Mortgage

For those that own a home, the idea of having no mortgage payment sounds pretty amazing. After all, a mortgage is often the largest debt you’ll take out in your lifetime.

As with most financial decisions, paying off the mortgage has benefits but it could also cause some unintended consequences.

Here are a few things you should consider before you start working to pay off your mortgage as fast as possible.

Benefits of paying off the mortgage

No more principal and interest payments

The first benefit of paying off your mortgage is the most obvious one.

Once your mortgage is paid off, you’ll no longer have to pay the principal and interest payments you’ve likely been making for years.

Reduced expenses translate to smaller potential nest egg needs

Getting rid of the mortgage payment can help you in more ways than one. First off, the reduction in expenses means you’ll need less money to live on each year.

If you stay in your home, this lower spending may extend into retirement. Essentially, you can probably get by with a smaller nest egg than you could have if you still had a mortgage payment when you retired.

Your return on your money is certain

Another benefit to paying down the mortgage is the return on your money is certain.

In exchange for prepaying your mortgage, you no longer have to pay interest on the principal you’ve already paid off. This isn’t like investing where the future is uncertain.

While you could earn 10% on an investment in a year, you could instead lose 20%.

Although the return is likely lower for prepaying your mortgage than you could earn investing over the long term, the certainty is worth the lower returns for many people.

You’ll have peace of mind

Finally, one of the largest benefits you’ll get for paying off your mortgage early isn’t a financial benefit at all. It’s emotional.

After you pay off your mortgage, you’ll have more peace of mind knowing you truly own your home.

You’ll never have to make another principal and interest payment again, assuming you don’t take out another loan on your home in the future.

Reasons you may not want to pay off the mortgage

Prepayment penalties

Not all mortgages allow you to make prepayments. Even if your mortgage does allow prepayments, you may have to pay a penalty to make prepayments.

These two issues can put a major dent in your mortgage pay off plans.

Losing tax-deductible interest

If you can make prepayments on your mortgage without penalty, there are still a handful of other reasons it may not be a good idea.

You could lose some tax-deductible interest as you pay off your mortgage. As your balance shrinks, the amount of interest you pay will shrink, too.

Due to recent tax law changes, this impact may not be as large for most people as it once was. That said, if you itemize your deductions and pay mortgage interest, your deductions could shrink.

You can’t quickly access home equity for free

If you’re using all your excess cash to pay off your mortgage, a time may pop up when you need access to cash for an emergency beyond what is in your emergency fund.

To access that cash, you’d have to refinance your home or take out a home equity loan or line of credit. After all, you can’t sell just one part of your home, such as an unused bedroom, to free up cash.

These loans could end up charging you a higher interest rate plus hundreds or thousands of dollars in closing costs.

Defaulting on your loan would be awful

Finally, a huge negative to paying your mortgage off is what happens if you default on your loan.

The bank doesn’t care if you have 300 mortgage payments left or 30 mortgage payments left. If you default on your loan, they can foreclose and take the whole home to get their money.

It’d be awful if you were so close to paying off your mortgage then got hit with a job loss that left you unable to make your payments. After the default, you’d be left with nothing.

Saving for Retirement

Saving for retirement is super important if you want to be able to eventually retire to a comfortable lifestyle.

Unfortunately, saving for retirement may seem difficult because the end goal, retirement, is often decades away.

Here are a few things to consider before deciding how much to save for retirement.

Benefits of saving for retirement

More time to allow compounding to work for you

One of the biggest benefits to saving for retirement first is the earlier you save the more you earn on your money thanks to compounding.

Here’s a quick example that shows how much more money you’d have at retirement based on how many years you’re able to save for retirement.

The below example assumes a return of 6% or 8% and an investment of $10,000 per year.

How Different Returns Affect Long-Term Gains

Years 6% avg. annual return 8% avg. annual return
10 $139,716 $156,455
20 $389,927 $424,229
30 $838,017 $1,223,459
40 $1,640,477 $2,797,810

Potentially better tax benefits

In addition to the benefit of compounding, saving for retirement generally providers better tax benefits.

In the case of traditional retirement accounts, you get to deduct the whole amount you contribute up to the annual limits as long as you qualify.

With Roth retirement accounts, your money will grow tax-free and can be withdrawn tax-free in retirement.

With mortgage interest, you really only benefit from the amount of interest you pay that is above the standard deduction unless you have enough other itemized deductions to cover the standard deduction.

Possibly a better return on your money

Currently, mortgage interest rates are at one of the lowest points in history.

If the stock market continues to offer historical returns, you could earn more money on your retirement investments than you’d save by paying off your mortgage early.

This requires a bit of luck since no one has a crystal ball to predict future returns.

It also requires a disciplined investing strategy to stay invested in the market over the long term rather than trying to time the market.

You can double dip with tax advantages

Finally, you can take advantage of the mortgage interest tax deduction and the retirement savings tax benefits.

If you save for retirement and still have a mortgage balance once you reach retirement age, you can then withdraw some of the money you saved for retirement to pay off your mortgage.

Why saving for retirement may not be the best choice for you

You might need to be mortgage free to retire

If you’re close to retirement, you don’t have the huge benefit of compounding to help as much as the younger generations do.

Additionally, people generally choose less risky investments the closer they are to retirement. This minimizes the risk of a large decrease in the investment value when a person needs it most.

Safer investments generally offer lower returns, which means you’ll have to save a large percentage of your income to start making progress toward your nest egg goals.

In some cases, the benefit of a paid off mortgage that reduces your future expenses may be a better financial choice to help you reach retirement faster.

Accessing retirement funds is difficult and often costly before retirement age

On the other end of the spectrum, younger people may have trouble if they put large amounts of money away for retirement. If they need to access their cash before they reach retirement age, things could get tricky.

Withdrawing money from retirement accounts before retirement age usually results in a penalty. Additionally, you’ll have to pay income tax if you had a traditional pre-tax retirement account.

If you want to retire early, there are some complex methods that could be used to access some money in retirement accounts. You’ll likely need to talk to a professional to set them up to make sure you don’t make any costly mistakes.

A Hybrid Approach

You don’t have to put all your eggs in one basket and only pay off the mortgage or only invest for retirement. In fact, most people would be much better off by doing a little bit of each.

Dave Ramsey even suggests doing both if you have enough disposable income.

His fourth baby step says to invest 15% of your household income in retirement accounts. Additionally, his sixth step has you paying off your home early.

This is a great example of how you can do both.

First, set aside a large enough percentage of your income to reach your retirement goals. Then, take any extra income you have available and pay off the mortgage.

If you’re a super saver when it comes to retirement, you may actually lose tax-advantaged savings options before you run out of disposable income to allocate.

In this case, it may make sense to take any savings above the tax-advantaged limits and use that to start paying down your mortgage balance. This way you can reduce your future retirement expenses.

The Choice Is Yours

Ultimately, the choice of whether to pay off your mortgage or save for retirement will come down to your preferences and your specific situation.

If you’re unsure of which option is best for you, consider consulting a fee-only financial advisor that’s also a fiduciary and charges by the hour.

These types of advisors must give you advice based on what is in your best interests. You don’t have to worry about commissions playing a factor in their recommendations, either.

Instead, you simply pay them for their time.

Saving for retirement and paying off a mortgage are both long-term goals. They'll take dedication and hard work to achieve.

That said, they’re both great goals to set yourself up for a brighter financial future.

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