Why a Paid-Off Home Could Hurt Your Retirement, According to Kevin Lum

Most people take out 30-year mortgages, so the thought of paying them off before retiring can provide significant financial relief. However, it’s not that simple.

In a YouTube video, Kevin Lum, certified financial planner (CFP), recently weighed the pros and cons of paying off your mortgage before retirement, including how that decision can actually be costly. It’s not a black-and-white choice and knowing all of the factors can help you make the right move for your finances.

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He shared the details and highlighted five key variables to consider. Here’s what you should know if you are approaching retirement with a mortgage.

Where Would the Money Come From

Do you have to pull funds from a high-yield savings account or withdraw from a traditional 401(k) to pay off your mortgage early? The way you tap into money matters, since traditional 401(k) withdrawals are treated as ordinary income, which may put you into a higher tax bracket.

If you sell from a traditional retirement plan, you also risk a higher tax rate for your Social Security benefits and the ordinary income boost can result in higher Irmaa fees, which will show up in Medicare Part B and Part D plans.

Selling assets also limits your potential upside during market rallies, but it also limits your potential losses if the market enters a correction.

Fixed vs. Flexible Spending Ratio

Lum explored the sequence of risk returns when explaining the difference between fixed and flexible expenses. You have to make mortgage payments each month until it’s paid off, but if your mortgage represents 30% to 40% of your annual spending, you have less flexibility to hold assets during market corrections.

Some people are forced to sell assets at meaningful losses just to keep making monthly mortgage payments. You can minimize this risk with a liquidity bucket, such as having enough cash on the side to cover at least one year’s worth of expenses. However, you can make your budget more flexible by paying your mortgage in full before you retire, which some people opt to do even if it means higher 401(k) withdrawals.

Your Behavior in Down Markets Is a Vital Variable

Do you panic sell or wait for the market to get better before investing? Selling assets at the wrong time may make it a better decision to pay off your mortgage early. However, if you are good at buying dips and remain patient, you can make a lot more money by staying in the market than rushing to pay off your mortgage before retirement.

What Is the Money Doing If It’s Not Being Used To Pay Off the Mortgage?

Lum asked his viewers this question to gauge if they could earn higher returns by sticking with their regular mortgage payment schedule instead of accelerating the process. Annualized market returns of 8% to 10% will beat your mortgage rate and you can leave portfolio growth on the table if you rush to pay off your mortgage.

Even some high-yield savings accounts and CDs offer higher yields than mortgage APRs, but that only applies if you got a mortgage before the pandemic or during its initial onset. Lum advised investors to consider their risk tolerance and where they are keeping their money before determining what to do with their remaining mortgage balance.

Paying It Off Early Can Tighten Your Liquidity

Paying off a mortgage early will reduce your liquidity since it takes a while to tap into home equity via a line of credit or a home equity loan. Savings accounts, brokerage accounts and retirement plans are far more accessible.

Using too much of your liquid cash to pay off your mortgage may force you to take out a loan during an emergency. That loan may have a higher APR than your current mortgage and you never know when you might need to cover an emergency. It’s much better to have liquidity than a fully paid home during those scenarios.

Is It Worth Paying Off Your Mortgage Early?

Paying off your mortgage can provide greater peace of mind and that psychological cost won’t show up in any spreadsheet. Having no mortgage also provides more financial flexibility, especially for people with many assets left over after paying it off.

Retirees care less about a higher net worth and more about preserving their wealth. They may be more focused on paying off a mortgage than optimizing their portfolios for the highest possible return. However, paying off a mortgage early can backfire if you are left with very little liquidity and investments.

This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.

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