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Retirement /
Personal Finance

Pay Off Your Mortgage Early or Save More for Retirement?

May 17th, 2023 | 3 min. read

By Jonathan DeMoss, CFA

financial adviser meeting with couple

By the time you leave the workforce, you ideally want every dollar available to make the most of retirement without worry. That’s why you might be wondering: Should I pay off my mortgage early or save more for retirement? In other words, does it make more sense to reduce your debt load or boost your savings for the future?

It’s an important decision. At Advance Capital Management, we know that everyone has different needs and preferences. So, there’s no single, correct answer. Plus, you can’t just rely on the math. Peace of mind matters, too. While one choice may technically be the optimal choice, if the other choice helps you sleep at night, then that’s the right choice for you – as long as it doesn’t cause you any financial harm.

When choosing whether to pay off your house or build up your nest egg, the decision depends on your circumstances. I can’t tell you specifically what the right answer is for your situation. However, in this article, I can explain the benefits and drawbacks of paying off your mortgage early versus saving more for retirement. This can help you make a more informed decision about what makes the most sense for you.

This article covers the following:

  • Benefits of paying off your mortgage early
  • Drawbacks of paying off your mortgage early
  • Where to get help planning your retirement

Benefits of paying off your mortgage early

Let’s start with the benefits. After all, who wants to carry debt into retirement?

One of the most significant benefits of paying down your mortgage early is significantly reducing the interest rate cost that you'll pay over time. That means giving less money to the bank and keeping more money in your pocket.

This brings us to another significant benefit. If you can pay off your mortgage early, you'll increase your cash flow to your household.

Together, you get another important benefit: a boost in your net worth.

Think about your balance sheet as an individual. You have assets and liabilities, and the difference is your net worth. For most people, a mortgage is their biggest liability. Therefore, if you can reduce that liability over time, you'll see your net worth improve as your liabilities drop, and the wealth building in your savings plan at work and in your individual retirement accounts grows.

Consider a study from the Dave Ramsey research team found that the average millionaire paid off their house in 11 years and 67% live in homes with paid-off mortgages.

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Drawbacks of paying off your mortgage early

So, what are some potential drawbacks of paying off your loan early?

One potential drawback often raised is that if you can invest in the market and earn a return greater than the interest rate on your home loan, you’re coming out ahead. However, that is the opportunity cost of paying down your mortgage early.

However, there is a significant caveat. Sure, the math in this instance works out. If you can earn 6% in the market while only paying 4% interest on your mortgage, you’ll earn 2% net interest by investing. But the problem is that you're not adjusting for the risk you're taking when you invest in the stock market.

Historically, the stock market, as represented by the S&P 500, has offered a risk premium, which is an amount of return over the government bond rate of about 5%. If the government bond rate provides a 2% return, you need a market return of 7% to be compensated for the risk you are taking.

You can apply this principle to your mortgage as well. For example, if you're paying 4% interest on your mortgage, you will need to earn a return of 9% to be compensated for the risk. You're not being compensated appropriately if you take anything less than that. So, that's something to factor into your decision.

Another potential downside of paying off your mortgage early is that you might not reap the rewards for quite a long time.

For example, let’s say you have a $500,000 30-year fixed-rate loan that charges 5% interest. Suppose you receive a $50,000 work bonus and decide to put it toward your loan. That reduces your loan balance to $450,000 and significantly lowers your interest rate cost. Both of which are great.

But, if you look at your mortgage payment time horizon, you've only reduced that by just over five years. So is it then worth taking $50,000 today to pay for a benefit you won’t experience until around 25 years later?

Some people would say that it’s not. They would rather have the $50,000 in cash today versus the payoff potential that will not take place for 25 years or so.

Where to get help planning your retirement

There are many major considerations when making big financial planning decisions, such as paying off your mortgage early or saving more for retirement.

Everyone’s situation is different. We have different needs and different goals. Therefore, there are things you may have to consider that are not in this article and that you may not even be aware of.

Speaking with a financial advisor can help you confidently make that decision. An advisor like myself, or any advisor at Advance Capital Management, can walk you through your choices and provide some long-term financial projections so that you can see what your situation may look like under different scenarios.

Jonathan DeMoss, CFA

Jonathan is a financial adviser committed to helping individuals and families feel confident about their financial well-being. Taking a holistic approach, he educates and guides clients on all of life’s financial decisions involving investments, retirement, taxes, insurance, estate planning and more. Jonathan holds the Chartered Financial Analyst Designation and is a Dave Ramsey SmartVestor Pro. He also co-hosts the finance YouTube channel, Under the Buttonwood Tree.