Prepaying your mortgage: A path to a secure retirement

For most people, a mortgage is the largest single financial obligation they ever assume. Paying off your mortgage before you retire is usually a wise decision; while you’ll still be responsible for taxes and insurance on the property, eliminating your monthly mortgage payment will relieve financial pressure on what generally is a reduced level of income. Owning your house outright will provide you with peace of mind, and can even provide you with a guaranteed source of income if your circumstances change.

Prepaying your mortgage

There are several methods for paying off your mortgage early. You can refinance your home for a shorter period of time, increasing your monthly payment substantially. For example, thirty-year loans can be refinanced and the time reduced to fifteen years; this allows you to pay down the principal more quickly. This method has certain drawbacks; for instance, if your income level falls, you will still be required to make the higher monthly payments. Even if your income remains the same, the increased mortgage payments can present a financial hardship in some cases. Make sure you’re ready to take on a long-term increase in your monthly costs before selecting this option.

If you have money to spare, you can make additional voluntary payments to your mortgage lender to reduce the principal amount owed on your home. The advantage to this method is its flexibility; if you have extra expenses, you can skip the extra payment for that month. By designating your extra payments to apply to the principal amount, you reduce both the principal and the interest owed. Thus, if you double your principal payment every month you will halve the time it takes to pay off your mortgage. Most lending companies will give you a detailed breakdown of how much of each month’s payment is applied to interest and how much is used to reduce the principal. In most cases, at the outset of a mortgage nearly all of your payment goes toward interest payments, while later in the life of the loan more and more is designated to apply to the principal amount owed. As a result, this method is less expensive and more effective if started soon after the mortgage period begins.

Disadvantages to prepayment

Some financial experts advise against paying off low-interest home loans. Instead, they suggest you should invest in tax-free retirement funds, mutual funds, or other low risk investments to maximize your return on your ready cash. Because the general economic trend favors the likelihood of inflation, it’s also possible that you will prepay your mortgage with money that is worth more than it would be if you had waited and paid your mortgage over the full term of the loan. While these may be valid arguments against prepayment, there are psychological benefits to paying off your mortgage that may outweigh these financial considerations.

Reverse mortgages

For retired homeowners who have paid off most or all of their original loan, reverse mortgages are becoming a popular means of financing retirement. These loans are often insured by the Federal Housing Administration, and allow homeowners to withdraw part or all of the equity in their home. Homeowners are allowed to continue to live in their home, and no payments are due until the homeowner no longer lives in the residence. Basically, you exchange equity in your home for a guaranteed monthly payment, line of credit, or a combination of both. This can provide an additional income for retired persons, and since it is not repaid for as long as you live in your home, you will not incur any additional expenses. It is important to note, however, that reverse mortgages will significantly reduce the value of your estate after your death, since they draw on the value of your home and effectively transfer ownership of your equity to a lending institution in return for ready cash.

Prepaying your mortgage can provide you with security, peace of mind, and even a guaranteed monthly income after retirement. Consult your financial advisor to find out if one of these prepayment or mortgage options is right for you.