Decisions about your mortgage can have a big impact on your finances, especially as you transition to retirement and start living off fixed income sources and investments. So, should you refinance your mortgage before you retire? And what about just paying off the loan with your savings?
Potential Benefits of Refinancing
If you refinance before retirement, it could offer several benefits. However, it's critical to weigh the pros and cons carefully before you do so.
Easier to Qualify
Refinancing while you're still working might help the approval process go smoothly. You probably have a steady income from work, but after retirement, you'll no longer have that employment income to help you qualify. As a result, it may be harder to get approved after retirement, and you may need to provide more documentation.
Lower Interest Costs
If you can refinance at a rate that's lower than your current rate, you'll likely save money on interest costs. Locking in a low rate could mean that every dollar you pay toward the loan makes a bigger dent in the loan balance.
However, be aware that it's possible to refinance and end up paying more in interest. If you stretch out your loan over a longer time frame, you could end up paying interest for more years, resulting in higher costs. For example, if you only have seven years remaining on your loan and you refinance into a 30-year loan, there's a good chance your future interest costs will increase.
Cash Flow Management
Sometimes monthly cash flow is the top priority. If you have a burdensome mortgage payment, refinancing with a lower interest rate or extended payment term could result in a lower payment.
Access to Cash
If you have substantial equity in your home, a cash-out refinance could provide liquid funds. You might use that money to improve your home, making it suitable as a "forever home." For example, you could complete landscaping projects, like xeriscaping, that require less effort (and potentially less money) to maintain each year.
Cash can be useful, but it's risky to borrow against your home. If you can't keep up with the loan payments, you risk losing your home in foreclosure, which is a stressful and expensive experience.
What About Paying Off the Mortgage?
If you have assets available, should you refinance your mortgage or just pay off the loan balance?
There's no right or wrong answer that applies to everybody. By evaluating your situation and goals, you can decide what is best. Be sure to consider where you have money available and any other ways you might use those funds.
Potential Tax Issues
If you plan to pay off your mortgage with money in pretax accounts, review that strategy with a certified public accountant to understand how this may unfold. You might owe income tax on the amount you withdraw, and taking a sizable withdrawal could push you into a higher tax bracket. Plus, it might affect how your Social Security benefits are taxed and how much you pay for Medicare premiums.
The impact might be less severe if you have funds in taxable accounts or Roth accounts. However, there are still trade-offs. Selling in taxable accounts can create capital gains, and cashing out Roth assets interrupts compounding that could benefit you in the future.
If you pay off mortgage debt with your savings and investments, you'll reduce the amount of money you have readily available. Whether you want funds for emergencies or other needs, be sure that you won't leave yourself with a cash flow problem after paying off a loan.
Getting money back out of the house can be difficult. For example, you might be able to refinance, get a reverse mortgage or even downsize to generate cash. However, you could face approval hurdles, and the process could be painfully slow.
If you need income from your retirement savings, using a substantial portion of your assets to pay off a home loan might be problematic. Those assets can supplement income from Social Security and pensions, and the more you have available, the better.
That said, you might also be able to use home equity to generate income in retirement. For example, reverse mortgages allow you to take monthly income or lump sum payments out of your home equity. If you go that route, it could work well to minimize the loan balance.
Does the Current Economic Environment Matter?
Interest rates are currently low, which can provide opportunities to refinance with a favorable rate.
On the other hand, low rates could also make paying off debt attractive, as you're earning relatively little on savings in bank accounts. Some fixed-income investments might also have low expected returns, although there's no way to predict exactly what they'll yield. Those factors, along with your loan's interest rate, should all be part of the decision. For example, if you're earning less than 1% on cash in a bank account and paying more than 3% on a loan, paying off your debt is worth evaluating.
There's also the question of stock markets. Returns on large U.S. stocks have been relatively high since 2009 (with some speed bumps along the way), and some people wonder if that can go on forever. While nobody can predict the future, you may be wondering if it makes sense to take some profits and pay down debt. Again, only time will tell, so you have to decide what seems appropriate now.
Factors to Consider
As you evaluate refinancing and managing debt, include the following factors in your analysis:
- Closing costs: You may have to pay transaction costs to refinance. Those costs could eat into any interest savings.
- Interest rate: It's typically best to refinance when you score a lower rate on your loan balance.
- How long you'll stay: Refinancing often costs money in the short term, and it may take several years to reap the benefits (after you recoup the money you spend on closing costs).
- Monthly payments: If you're refinancing to lock in a lower monthly payment, be aware of some potential trade-offs. When you extend your loan term (making it last for more years than your existing loan), you often pay more in interest. Still, that might be a price you're willing to pay.
- Investment risks and returns: Paying off the mortgage is a guaranteed way to avoid paying future interest charges on that loan. However, if you have money invested, you can't predict how much you'll earn or lose. Depending on your investment strategy and appetite for risk, you may find either paying off debt or staying invested is more appealing.
When Is the Best Time to Refinance?
It generally makes sense to refinance whenever doing so would save you a meaningful amount of money or improve your finances. With lower interest costs or a lower monthly payment, you may improve your chances of success in retirement.
It's also important to consider approval requirements. Having sufficient income to repay a loan is essential, and you might have the best chances of approval if you refinance during your working years.
The Bottom Line
Review your mortgage to understand how much you pay in interest, and discuss your options with a mortgage professional. If you can get a substantially lower rate or secure a monthly payment that fits your budget, it could make sense to move forward, but be sure to research everything with the big picture in mind before you make a decision.