Home Fixed interest Carry a mortgage in retirement? You might regret it

Carry a mortgage in retirement? You might regret it


As you approach retirement, you may have a large mortgage balance over your head. The average household in their 60s has about $243,000 in outstanding mortgage debt. Paying off these loans can be a smart move for many future retirees.

A mortgage is a fixed income asset that you have sold

Most people diversify their portfolios by allocating part of their investments to stocks and the rest to fixed income investments like bonds. A mortgage is a fixed income asset. There’s a whole market for mortgage-backed securities, which are basically just pools of mortgages.

If you have a mortgage balance, it’s like selling a mortgage short. In other words, it is a negative fixed income asset.

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As such, you should adjust your portfolio to account for the mortgage balance against your allocation of bonds and other fixed income assets. For example, suppose you want to maintain a 60/40 split between stocks and fixed income securities in a $1,000,000 portfolio with a mortgage balance of $200,000. You would need $480,000 of stocks and $520,000 of fixed income assets in your investment portfolio to produce a net 60/40 split. This is because the fixed income allocation is reduced by your mortgage balance of $200,000.

If you’re comfortable doing the math and balancing a mortgage against your fixed income assets, then maybe keeping a mortgage in retirement is right for you. But you also need to consider whether holding the mortgage is the best use of your money.

What is the return on paying off a mortgage loan?

2020 and 2021 have offered many people an opportune time to refinance their current loans. Many people saw their mortgage rates fall below 3% when they refinanced during this period. With today’s inflation rates, these mortgages have negative real interest rates. In other words, paying the minimum on this debt is a good idea because it increases your long-term purchasing power.

Generally speaking, investors with a long-term horizon might consider leveraging their mortgage to invest more in stocks. Stocks have higher expected returns over the long term, but generate more volatility in a portfolio. Young investors can usually handle this increased volatility, which is heightened by maintaining a large mortgage balance. In the long run, it can produce a bigger nest egg to retire on.

But retirees are looking to live off their wallets, and capital preservation becomes more important as you approach retirement and move through the early years of your investments. And because a mortgage can have a significant impact on portfolio decisions, such as how much to allocate to bonds, a retiree should compare the expected value of paying off a mortgage to buying bonds.

For a mortgage, the calculation is simple. If you take the standard deduction on your taxes, the yield is the mortgage interest rate.

Determining a return expectation for investing in bonds takes a bit of guesswork. Historically, however, Treasuries have simply tracked inflation while providing a counterweight to equities. Going forward, investors shouldn’t expect much more than inflation-matching returns from Treasuries.

The Fed plans to bring inflation down to around 2.3% by 2024. Most mortgages have an interest rate above this figure. So, by paying off the mortgage, you’ll get a guaranteed positive real return, which could outperform the treasury bills in your portfolio. (If you’re very bullish on bonds, however, you might want to leverage your mortgage to keep more money in the asset class.)

You can often get a better long-term real return by selling bonds and paying off your mortgage.

Important Real Life Considerations

Some important factors can tip the scales in favor of continuing to slowly pay down your mortgage throughout retirement.

There are likely tax consequences to selling assets from your portfolio to pay off your loan. If a significant portion of your portfolio is in a tax-advantaged retirement account, you could end up paying a hefty tax bill to pay off your mortgage all at once. Or if you have assets with a lot of unrealized capital gains, it might be more beneficial to spread the sale of those securities over several years.

The bond market is currently having one of its worst years for investors. It can be difficult to sell when your investment is down 10% to 20%, but investors should always look at expected returns going forward. If you believe the market is about to rebound strongly and outperform, you may want to hold on to your mortgage in order to hold more bonds. But if you don’t think bonds will exceed their historical real yields over the medium to long term, it makes perfect sense to pay off the mortgage.

You don’t have to pay off the mortgage all at once. Maybe your mortgage repayment plan near retirement is just allocating the portion of your retirement savings contributions that would instead go toward bonds toward your mortgage. This way, you can hold your current assets without selling, without incurring tax consequences.

Retirees who have enough deductions to itemize on their tax returns may also receive less benefit by paying off their mortgage. The interest rate should be reduced by the tax deduction on the mortgage interest payment, so be sure to factor this into your calculations.

Paying off your mortgage will simplify your retirement planning. Not only will this make it easier to manage a balanced retirement portfolio, but it will also ensure that your expenses remain constant throughout retirement. You won’t have a big chunk to lose mid-retirement once you’ve paid off the loan organically. So not only can it make mathematical sense, but it can also make planning more practical.