Should Retirees Pay Off All of Their Debt?
Before you put a match to your mortgage, think about whether you will have enough liquid assets for emergencies — and routine expenses
America, by and large, is a country in debt. Total household debt in the U.S. rose to $17.05 trillion in the first quarter of 2023, according to the latest data from the Federal Reserve Bank of New York. Mortgage balances were at $12.04 trillion, auto loans were at $1.56 trillion and credit card balances stood at $986 billion.
Debt-free living is the goal of many retirees (as well as many people who are still working). But is this really the best use of your funds? Here are some factors to consider if you're a retiree thinking of paying off all of your debt.
Interest Rates Rule
The interest rate on the debt is always a consideration — whether it's your home, car, credit card debt or other type of loan. "If the debt carries a high interest rate, such as credit card debt, it's usually a good idea to pay it off as soon as possible to avoid accumulating more interest," says Kortney Ziegler, CEO and founder of WellMoney and a Stanford University Fellow.
But if you're thinking of paying off debt with a low interest rate, Ziegler says it might make more sense to reconsider.
"There are some 'good debts,' such as mortgage debt, especially if it was refinanced in the last decade when rates were so incredibly low."
John Cunnison, chief investment officer at Baker Boyer National Bank in Walla Walla, Washington, agrees that paying off high-rate debts like credit card balances is a good idea. "But there are some 'good debts,' such as mortgage debt, especially if it was refinanced in the last decade when rates were so incredibly low."
In fact, he says many people are receiving higher yields on their savings accounts than they're paying in mortgage interest. "That's the definition of 'good debt,' and it shouldn't be paid off," Cunnison explains.
Scott Ashline, private wealth advisor with Northwestern Mutual, tells us that, in addition to a low interest rate, a home mortgage generally has tax benefits, and that's why it's thought of as the kind of debt you want to keep.
"If the interest rate is low on your mortgage, it may be worthwhile to put that money toward an investment account or a high-yield savings account, rather than trying to pay off your mortgage before or in retirement," Ashline says.
When trying to decide if you want to pay down all of your debts (mortgage included) or just pay off certain types of debt, it's important to think strategically.
"Based on today's interest rate environment, every $10,000 reduction in loan amount will reduce the monthly mortgage payment by just over $60," Jason Lerner, area development manager at George Mason Mortgage in Towson, Maryland, says. However, using the same $10,000 to reduce your auto loan would have a greater impact in reducing your overall monthly expenses, he says.
While being completely out of debt is a marvelous feeling, consider how much you will have left to live on if you choose that route. Aaron Dorn, the chairman, president and CEO of Studio Bank in Nashville, Tennessee, tells us that you need a clear understanding of how much cash you will need on a recurring basis.
"It is important to remember that even if you retire at age 65, we need to plan for you to potentially live to age 100."
"In retirement, cash flow is king, and it's important to ensure that your daily needs can be met as comfortably as possible." A paid-off house is wonderful, but Dorn says you cannot eat a house if you get hungry.
And when you think about those daily needs, also factor in how long you expect to have them. "It is important to remember that even if you retire at age 65, we need to plan for you to potentially live to age 100," says Ashline.
He points to Northwestern Mutual's 2023 Planning & Progress Study, which found that Americans, on average, say there is a 45% chance they will outlive their savings and yet one-third (33%) haven't taken any steps to address this disparity.
Prepare for Problems
Even if you pay off your home, keep in mind that homeownership requires maintenance. You may need a new roof, HVAC, electrical work — any part of your house may, over time, need to be fixed or replaced. The same goes for appliances and furniture.
"Paying off debt when not needed takes away from resources that could have been used for home improvements or furnishing the home," warns Lerner.
In addition to daily expenses and routine maintenance, you will need to make sure you have enough for unexpected expenses — anything from a major car repair to a medical expense that even with insurance, could be quite costly. "It's important to ensure that paying off debt won't leave you without a sufficient emergency fund," says Ziegler.
If you want to refinance or purchase a new home, you may not want to pay off all of your debts. "This is something to avoid unless a mortgage professional tells you it's necessary for mortgage approval," Lerner says.
You Can Have Too Little Debt
He says your credit score and debt-to-income ratio are the two most significant factors that dictate mortgage approval. If you pay off all of your debts, Lerner explains that this may hurt a retiree's credit score.
"A retiree can often improve their debt-to-income ratio by increasing their monthly disbursements from retirement assets rather than paying off debt to decrease their monthly payments," he says.
Here's something else to weigh: potential investment returns compared to the debt. "If you think you can achieve a long-term average annual return of 5% to 7% on an investment portfolio and your mortgage is at 3%, then keep the mortgage," advises Cunnison. But if your mortgage interest is higher than the expected portfolio return, he says it might be better to retire the mortgage.
Defend that Deduction
Ziegler agrees and says it's a matter of risk tolerance. He acknowledges that investing the money could potentially bring higher returns than reducing or eliminating debt. "But investing comes with risk," he adds, "and if the retiree is risk-averse, they might find paying off the debt to be a safer option."
If you're thinking about paying off your mortgage, consider what else this will entail. "Some forms of debt, such as a mortgage, come with tax benefits, like the mortgage interest deduction," says Ziegler. If you pay off the mortgage, you will no longer get those types of tax breaks, so the amount you will owe to the IRS may increase.
"Debt makes many of us uncomfortable, and there can be material benefits to retiring debt (like knowing no one can put you out of your home), even if the math may not make it the optimal path."
However, paying off debt provides a feeling like no other.
"As a debt-free retiree, you'll save money on interest and have more breathing room during times of inflation or economic uncertainty," says Ashline.
Along with potentially improving your financial well-being, you may also be less stressed. A 2022 American Psychological Association survey, Stress in America, found that 76% of Americans list the rise in prices of everyday items (gas, energy, groceries) as a significant source of stress. And at least being out of debt is one way that retirees can take a breather.
"An often-overlooked factor is the emotional feeling toward having debt," explains Cunnison. "Debt makes many of us uncomfortable, and there can be material benefits to retiring debt (like knowing no one can put you out of your home), even if the math may not make it the optimal path."