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Should I Pay Off My Mortgage in Retirement? Thumbnail

Should I Pay Off My Mortgage in Retirement?


[00:00:03] Typically, you typically do not want to pay off a mortgage. Typically you want to have that home equity line of credit in place. In case you need money, you need a lump sum so that you're not depleting your assets. And here's why, here's an example. Why one question I get, should I pay off my mortgage in retirement?

[00:00:21] Let's assume we have a mortgage at 500, 000. Now our choice is we could take 500, 000 from our investments and pay the mortgage off all at once, or I could apply for a mortgage for 500, 000 and simply pay the monthly payments. Now, what happens is right now, interest rates have come up. So say the mortgage right now is 7%.

[00:00:41] And so you're getting 5 percent on your investments. If we have a 10 year mortgage over the 10 years, the total cost of your loan is 696, 650. However, the 500, 000 compounding at 5 percent per year, which is very easy for me to get right now because interest rates have come up so I can get 5 percent almost risk free, would grow to over 814, 000.

[00:01:07] So from a financial perspective, It's in your best interest to not pay off your mortgage to not pay cash for a house in retirement, but to keep your money in place compounding and utilizing the law of large numbers after 10 years, you'd have 814, 000 versus the 696 in total loan calls. So you'd have an extra 117, 000 available to you for retirement.

[00:01:32] After 20 years, this 500, 000 would grow to over 1. 3 million. The total cost of a loan would be 930. So you'd have an extra 396, 000. And then on a 30 year loan, this 500, 000 would compound to over 2. 1 million. But the total cost of a 30 year mortgage would only be 1. 1 million. And you'd have an extra million dollars.

[00:01:56] Almost available to you 30 years in the future when you're old, you can't earn any more money and you may need that money for end of life expenses. Now I want to show you why this works. So this is, you can check this out at bankrate. com. You can use an amortization schedule. This is counterintuitive because if you look here, you say, if my investments are making 5%, but the loan is 7%, How can I have more money over time with a 5 percent loan and the mortgage has a higher interest rate than what I'm earning on the money?

[00:02:29] That doesn't make any sense. Now, we refinanced our mortgage when the interest rates were very low. So our mortgage rate is like 2. 8%, right? So I'll never pay that off, right? Because I can certainly earn a rate of return higher than what my mortgage payment is. But this doesn't make sense. But the reason this works is because of how amortization work.

[00:02:49] This is an amortization calculator. So a 500, 000 loan for 30 years at a 7 percent interest rate. The total cost of the loan is 1, 197, 000, which is what I showed you here. The reason that happens is because the balance goes down over time. So we started with a 500, 000 loan, but as you're paying the monthly payment, a portion of that goes to principal and that principle is being reduced over time.

[00:03:20] So now the 7% Is applying to a steadily decreasing balance. So we started with 500, 000. It goes to 46 down to 490. Then it's 420. Then it's coming down and down till finally the 7 percent is applied to 9, 000 right in year 29. So the total cost of the loan is only 1. 1 million. The opposite happens to this 5%.

[00:03:44] So while the mortgage balance is decreasing over time, this balance is increasing. So the 5 percent is being applied to a higher number that's ever increasing. And then the law of large numbers kicks in. So the compounding is in your favor and it's a very powerful effect. So you start with a 500, 000 investment.

[00:04:06] 5 percent after a year is 525, 000, then it goes up here. So over time you end up with more money. So from a financial perspective, it probably does not make sense for you to part with your lump sums of money in retirement because of this dynamic that I'm showing you right now. And the assets are irreplaceable.

[00:04:26] So once you part with that money, you can't earn it back. The money becomes more like a, it's like you're a farmer and you have four mules That work that they're working the farm. You could sell a mule at any time and get money for it, but now you only have three mules working in your favor. You need all these mules, all the money working for your benefit in retirement that you possibly can.

[00:04:49] And you may need big lumps of money at the end because of the long term care events that I talked about several hundred thousand dollars. You may have to write some really big checks toward the back end of your retirement. So we want to preserve these assets as long as possible.