Sunday, February 18, 2007

Eliminating Mortgage Debt - New Thinking

Last week, my retirement spending analysis showed virtually no reduction in daily expenses during retirement. This was a bit surprising since the rule of thumb is one can live on 80% of one's current income when retired. After thinking more about this, I realized the issue was our home mortgage.

Currently, our mortgage payment (principal and interest only) equals 19% of our after-tax income. If we can eliminate our mortgage debt by or within a few years of retirement, our income needs will be reduced by about 20%. Eliminating our mortgage debt will significantly improve our ability to retire.

We currently have a 30-year fixed mortgage at 5.375%.

Our current plan is to pay the mortgage off in about 15 years by making additional principal payments. One way is to increase the monthly payment by about 50% as described in Paying Off A Home Mortgage Earlier. We have chosen another way of making one annual lump sum payment equal to about 4% of the original mortgage principal. Either way will pay off the mortgage in about 12 more years.

However, I also want to cover the possibility of retiring earlier than 12 years from now. If I get the opportunity to retire in my 40s :-), I might not have paid off the mortgage. Here is how I plan to eliminate the mortgage in less than 12 years, if needed.

  1. Continue with our current mortgage payoff plan. At this time, I will not pay any more additional funds against the mortgage. Doing so would sacrifice the savings we are putting against our retirement. I would rather keep the money in liquid assets versus illiquid assets such as our house.

  2. Assign a part of current and future savings to a 50% or greater lump sum mortgage payoff. This money would be used to payoff part of the mortgage, if needed. Otherwise, the fund will remain part of our emergency or retirement funds.

  3. Identify other potential sources of funds to pay off the remaining balance in lump sum. If I can retire earlier than planned, it will likely be because of a windfall. Windfalls would include the following: excess returns from investments/stock options, or severance pay. Any of these windfalls could be used to payoff the remaining mortgage balance.

In the past, I would have been uncomfortable putting so much money into an illiquid asset such as a house during retirement. However, Retirement Planning - A Staged Approach has convinced me that the value of one's house can be effectively used for retirement income.

For more New Beginnings, check back every Sunday for the next segment.

Photo Credit:, Michael S. Richter

This is not financial advice. Please consult a professional advisor.

Copyright © 2007 Achievement Catalyst, LLC


traineeinvestor said...

I have a similar issue with the last secheduled payment on my home mortgage falling due several years after I hope to retire.

With an interest rates being where they are and a reasonable time horizon to work with, I have decided to put the extra payments into other investments. When the time comes to retire, I should have a lump sum greater that the remaining principal on my mortgage.

The long run returns on the stock market have generally been well above the interest rate I am paying and the time horizon is just about long enough to address the risks of investing in equities. Of course I recognise that this strategy carries some risk, which I am prepared to live with.

Super Saver said...

Trainee Investor,

Thanks for your comment and sharing your approach.

I like your system of investing the stock market to pay off a mortgage. Given the stock market has returned 10% on average, it should easily exceed the after tax mortgage interest over a long period. I will include the approach in my future thinking.

mOOm said...

Yes a home mortgage is a relatively cheap source of finance for investment. I wouldn't rush to pay it off unless you are very risk averse.

Anonymous said...

At 5.375%, what's the rush to pay it off earlier? If you want to increase your retirement assets, maybe you can keep paying only the interests and principle of your mortgage and invest the additional principle (or lump sum) you plan to put toward mortgage balance.

Super Saver said...

mOOm and Sun,

Thanks for comments. I agree that on average, investments should have better returns than my interest rate of 5.375%, especially after tax. However, since our mortgage payment is 19% of our current after tax income, I'd also like to eliminate that fixed payment in retirement. We're still trying to figure out the right balance. I guess I am a bit risk averse in this case :-)

Adventures In Money Making said...

don't really have anything new to add, except i agree. why bother paying off something thats so cheap?