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Suze Orman: You're not ready to retire until you've done this

Money logo Money 11/14/2017 Suze Orman
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Video by CNBC

My fellow baby boomers, we need to talk. More than one in three homeowners 65 or older is still paying off a mortgage. That’s a steep increase since the turn of the century, when less than 25% of older homeowners had housing debt.

And it’s not as if the remaining debt is some inconsequential sum. The median amount still owed among the 65 and older crowd was more than $80,000.

This is so not okay. If your intention is to stay put in the house you currently live in, you should make it your top priority right now to get the mortgage paid off before you retire. I will get to the financial reasoning in a minute. But just as important is the emotional payoff.

One of the best parts of my work is that I am constantly meeting people who want to talk about their financial plan. Just the other day I called to order something, and the salesperson was not shy asking for some retirement advice. I love it that people are so eager to share their lives. And when speaking with thousands of retirees over the years, there are two things I have never, ever heard:

“Oh, Suze, I am losing sleep because I don’t have a mortgage payment.”

“Suze, I really regret that I am living debt-free.”

Look, there are so many knowable unknowns when it comes to retirement. Among them: How long will you live? The rate of return on your portfolio? The cost of medical care for an older you? A financial meltdown right when you are ready to retire (see 2008)?

So you should be grabbing every opportunity you can to eliminate the known risks in your retirement plan.

One of my most important laws of money is to invest in the known. If you know you want to stay in your home, paying off the mortgage is a great way to build security. You will be more protected from any number of unknowns: being forced to leave your job sooner than you expected; or the possibility that tax rates will rise, effectively reducing the value of what you have saved in your traditional retirement accounts; or the risk that investment returns will disappoint.

And you will be extra glad to be mortgage-free when the markets fall. By now you’re an old hand who knows that bear markets are just a natural part of the investment cycle. Not fun, but not exactly surprising. Those are the times when being able to rein in your spending a bit can be such a big help.

Reducing how much you need to withdraw from your investment accounts means you might need to sell less when markets are down, and give your savings time to recover.

So, what can you do to get out of mortgage debt?

Rerun the numbers

Ask your loan servicer to run a fresh amortization schedule that has the mortgage paid off by 65.

As I explained earlier, continuing to work until you are 70 is a key way to build retirement security. But you still want the mortgage paid off by 65, if not earlier. Paying off your mortgage makes it more practical to downshift to a less demanding job in your sixties. And let’s face it, it will make it easier if you find yourself pushed out or downsized before you intended to retire.

Alternatively, you can use online calculators. Bankrate.com and Calculator.com both have free online “mortgage payoff calculators” where you can input extra monthly or annual payments and get a readout of how much that will speed up getting your mortgage paid off.

Cash out wisely

I know plenty of you have done a great job building a big emergency fund. I often hear from people who rightfully boast of their stuffed savings accounts, knowing I am adamant that having at least an eight-month emergency fund is my idea of true security. (Yes, I know MONEY has typically suggested three to six months. I prefer an even safer cushion.)

But, people, too much of a good thing can be a wasted opportunity. If you have more than eight months to one year of living costs tucked away, and you’re near retirement but still paying a mortgage, I think you should consider using your excess emergency funds to pay down the mortgage.

We’re still stuck in a world where even the best of the savings and CD deals tend to pay less than 2% interest. And that interest is taxable. That’s at least 1.5 percentage points less than what you are likely paying on a 30-year fixed-rate mortgage; the recent low was 3.3% in 2012.

This makes sense

Don’t you dare go down the rabbit hole of how much you like your mortgage-interest deduction. You’re telling me you have the means to pay down debt, but don’t want to because of the tax break?

Even if you’re in the 35% federal tax bracket, your net mortgage rate is still above 2%. And you’d be playing into the lender’s hand. Lenders stack mortgages so they collect mostly interest in the early years of your loan. That way, when you move, or prepay, they will have pocketed plenty of interest.

On a standard 30-year fixed-rate mortgage about two-thirds of the payment in the early years goes toward interest. By year 15, less than 40% of the payment is for interest. If you are within 10 years of paying off your mortgage, you’re getting very little bang from the mortgage-interest deduction, as just 30% of your payment is interest.

Stop saving so much

Yep, I just went there. I want you to save less so you have more cash to pay down your mortgage. What about the higher catch-up contribution limits? Am I really suggesting you don’t take advantage of that last-minute opportunity to turbocharge your savings? Yes, I am.

Bet that got your attention. To be clear, I always want everyone to contribute enough to their 401(k) to grab the maximum match. That is to never be turned down. But beyond that, I say stop saving at work and plow the extra money that will pop into your paycheck to reducing your mortgage debt ASAP.

If that sounds full-on crazy to you, it’s not. Let’s say you have a $300,000 mortgage with a monthly payment of $1,389, or $16,668 a year. After 20 years of paying $1,389 a month you still owe $138,850. If you intend to use retirement funds from traditional 401(k)s or IRAs to make another 10 years of mortgage payments in retirement, you’re going to need to pull out a lot more than $16,668 a year. Remember: You will owe ordinary income tax on every penny that comes out of those accounts.

If your combined federal and state tax rate is 25%, you would need to pull out more than $22,000 a year just to net the $16,668 for the mortgage. Even if you’ve managed to save $1 million in retirement accounts, that is going to be a big bite out of what you can safely withdraw over a 30-year retirement horizon.

A general rule of thumb suggests a 4% annual withdrawal rate is sustainable; you’re going to spend more than half of that just on the mortgage! Even worse, those bigger withdrawals mean you will report higher taxable income. That can end up pushing you into a higher tax bracket than you thought you’d be in once you retire.

That’s why I am adamant that paying off the mortgage before retirement takes financial—and emotional—pressure off you.

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