Early Retirement: How Important Is It to Pay Off Your Mortgage First?

When you plan for early retirement, you’re not just planning for the last few years of your life. It’s more like preparing for the second half of your life. This time frame will likely span a number of decades.

One of the best ways to successfully prepare is to get out of all debt, including (and especially) your mortgage. It's a necessary step for early retirement and one that will provide financial benefits throughout your retirement years.

While there are some who take a different view, here are the reasons we think you should pay off your mortgage before you retire.

Removing Your Largest Expense

Preparing for early retirement isn't all about saving and investing money. The "B-side" strategy is lowering your basic living expenses. The lower they are, the less income you'll need, and the fewer assets will be necessary to generate that income.

You should carefully consider cutting as many expenses as you can. The biggest benefit, though, will come from cutting or eliminating your largest budget items.

It's likely that your mortgage payment is the largest single expense in your budget. By paying it off, you will drop your cost of living substantially. That means that you will either need less income in retirement, or you will have extra room in your budget for other purposes.

Freeing Up the Equity in Your Home for a Future Sale

If you retire in your 40s or 50s, you'll need to provide income for 30, 40, and maybe even 50 years. No matter how large your investment portfolio is at retirement, there will be times in the future when it will need a cash infusion. One of the best ways to do that is by selling your home and moving the capital to your investment portfolio. If you own your house free-and-clear, you will maximize the amount of equity you'll get from the sale.

You may also decide at some point that you want to downsize your living arrangement to lower your living expenses even more. That is always easier to do if you have no mortgage on the home that you are selling.

You may decide to buy a less expensive home. Maybe you’ll even rent a home, then reinvest the remaining proceeds into your investment portfolio. Whatever you choose to do, having a mortgage-free home will make it both easier and more beneficial to do.

Enabling You to Save More Money

The sooner you can pay off your mortgage, the more money you will have available to save for retirement. And with early retirement that's even more important. Once your mortgage is paid, you can redirect that monthly payment amount into your investment portfolio. This will supercharge your savings efforts.

But it's also important to recognize that saving money won't stop the day you retire. There will always be unexpected expenses, and having extra savings at all times will be an important sub-strategy. Being prepared will keep you from needing to raid your primary investments to pay for contingencies.

Learn More About Painless Money Saving Strategies

Just as has been the case throughout your working life, you will need to have an ongoing strategy to save money on a regular basis. Having your mortgage paid off will help you to do exactly that.

In Preparation for a Less Generous Tax Deduction

People often buy the most expensive house they can afford, based on the assumption that the monthly payment will be at least partially subsidized by the federal government. Both mortgage interest and real estate taxes are deductible for income tax purposes. So, a large chunk of the typical monthly house payment will provide tax savings.

But when you retire, it's likely that you will be in a much lower income tax bracket. At that point, the tax deduction benefit will be minimal. That will mean that you will feel the full effect of your monthly mortgage payment. For example, you may drop from the 28% marginal tax rate, down to the 15% level. That will just about cut your mortgage tax deduction in half.

By paying off your mortgage, you can eliminate a large monthly payment that is no longer largely subsidized by the federal income tax code.

Just in Case You Want to Rent it Out for Income

Once you retire, you may find yourself relying on a variety of income sources. If your mortgage is paid, you can rent out your current home and receive a much larger net income as a result.

This is especially important should you decide that you want to temporarily change locations. For example, it’s not uncommon for early retirees to decide to spend some time living abroad. Should you get bitten by that bug, you can simply rent out your home and collect a nice monthly cash flow while you’re away.

In addition, rental income from your home could be a nice counterbalance during a time when the financial markets are in decline. That rent income could provide you with valuable and reliable cash flow that will reduce your reliance on your portfolio during a bear market. Think of it as a backdoor capital preservation strategy.

Peace of Mind

Debt and retirement are not comfortable traveling companions. That’s because debt is a significant source of stress. That’s not just for the fact that it requires a monthly payment, but also because it means that you owe someone money. Being out of debt, including on your home, can give you that peaceful feeling that will be necessary to fully enjoy your retirement.

Early retirement, in particular, isn't just about having enough income to be able to retire. It's also about the freedom that comes from knowing that you don't owe anything to anyone. That feeling alone can be more valuable than money itself and can help to create a much more relaxed lifestyle.

So if you are planning to retire early, certainly save and invest as much money as you can. But at the same time, have a comprehensive plan to get out of debt. In particular, focus on paying off your mortgage. You'll find that it's one of the best early retirement strategies you can implement.