Is It Okay to Retire with Mortgage Debt?

I have a fond memory of my maternal Grandfather sitting me down before I graduated from college and telling me, “Steve, whatever you do, don’t borrow money.” While Grandpa John lived far from an easy life as a dairy farmer in Nebraska, there was no mortgage on the farm when he inherited it after his father died. Circumstances now, however, are just different and heading into retirement with a mortgage might be perfectly reasonable. Quick rule of thumb: Compare the interest rate on your mortgage with your projected investment returns and allocate your dollars to the higher number.

Good debt versus bad debt

In the most basic terms, good debt is when we borrow for something that will still have value after the debt is paid off. Our homes are the best example of this but car and truck loans can apply also as we can keep driving them after the loan is retired – and should.

Bad debt is borrowing for items that disappear before the bill arrives – particularly credit card debt. For instance, 6-month old credit card debt for the Chinese food you can’t remember eating – bad debt. Guidance on debt is more complicated than what I just described, but we’ll leave that for a subsequent blog post.

Debt heading into retirement

Managing cash flow is the cornerstone of retirement planning so retirees can maintain their desired standard of living without risk of their assets dying before they do. Here are the broad steps:

1. Determine your annual expenses during retirement;
2. Determine the amount of Social Security benefits you will receive and when makes the most sense for you to start taking them;
3. Determine how much annual withdrawals of 4-5% from your retirement savings will yield. For instance, $1 Million in retirement savings will produce about $40,000 year in pre-tax income. Withdrawal rates higher than that and you’ll risk outliving your assets;
4. Now, will your estimated income cover your estimated expenses, including your mortgage payments?

No: If the mortgage payments consume too much cash flow, consider paying off the debt prior to retiring. Maybe you work a bit longer until your mortgage is paid off or you accumulate enough retirement savings to generate income sufficient to cover your mortgage payment each month. Maybe a part-time job would be enough to cover the expense. Not fun options to consider but better to plan ahead than run out of money later.

Yes: If the mortgage payments are still affordable in retirement, consider whether it makes sense to pay off the mortgage early or simply continue making the regular, monthly payments. Here’s how: Determine where you can get the best return on your money – by paying the interest rate on the mortgage or generating investment returns. For instance, if your mortgage rate is 4% but you estimate your retirement savings will return 5-6% each year, the better return is your investments. So, you are better off keeping your money invested and paying off your mortgage as scheduled. Of course, the reverse is also true – if your mortgage rate is higher than your investment returns, pay down the mortgage.

There is a natural, and understandable, instinct in most of us to want to pay off our mortgage prior to retirement. In fact, it’s considered a kind of rite of passage. Yep, the missus and I paid off the house and finally have the kids off the payroll! But, keeping the mortgage for a few years into retirement may actually be the smart thing to do. As always, making a plan will help you make the best decision.

Steve Byars, CFP®