Paying Off Mortgage vs. Retirement Savings

Point of Interest

Planning for your future means coming up with a plan that’s a healthy mix of paying down debt while building savings. While you may be tempted to focus all your efforts on one or the other, it is possible to tackle a mortgage and retirement savings at the same time. Take some time and analyze your unique financial situation. If you go over the numbers for several different scenarios, you can find the best plan forward to achieve both goals.

Pay off your mortgage! Save for retirement!  Planning for your financial future can seem overwhelming, especially when different advisors are telling you to focus on several different aspects of your financial picture, all at the same time. Should you pay off your mortgage first or prioritize saving for retirement? Can you do both?

Your money supply is not endless, so you’ll need to weigh your options and decide how to allocate your funds. The specific details of your situation will help to dictate what your financial savings and debt payment plan will look like for the short term and long term future. 

Paying down your mortgage first

There are positives to paying down your mortgage before saving for retirement. As you’re well aware, your mortgage is a large loan that you’ll pay interest on for the life of the agreement. The larger the amount of money that you owe, the more interest you will be paying over the long run. If you decide to make additional or larger payments to your mortgage, you can save significantly on interest over the long term.

Additionally, the more you pay towards your mortgage principle, the quicker you will pay off the entire loan. It might not sound like a big deal now, but shaving several years off your loan terms could be a big deal when you get closer to retirement. It would be one less major expense you have every month. 

“Prioritizing mortgage payoff can have an advantage: Paying $50 extra a month isn’t much, but offers big benefits when it comes to cutting down on a loan’s principal balance,” Andrina Valdes, Executive Sales Leader & COO of Cornerstone Home Lending, Inc., said.

“On a typical 30-year loan, you could save over $20,000 in interest, though individual loan terms can vary. A really important note when making extra mortgage payments: Make sure your loan servicer knows you want these funds put toward your principal since this doesn’t happen automatically.”

As Valdes points out, the real benefit of making additional payments on your mortgage is paying down the principal. When you lower the total amount that you owe on, you lower your interest responsibility, which can result in long term savings.

Most mortgages are set up to where borrowers pay more toward the interest with each payment early in the loan and more to principal later in the loan. While you will still see benefits from extra payments at any point in the loan, the advantages should be greater when additional or larger payments are made earlier in the life of the loan. Do make sure you specify you want the additional payments going towards the principal, though.

The drawback to prioritizing paying your mortgage first is that the money you use to pay down your mortgage stays at risk of possible default in the future. Your home is your collateral on your loan. If you are ever unable to continue making payments, you’re going to lose the extra efforts you put into paying down your mortgage rather than saving for retirement. 

Paying down your mortgage also limits your liquidity. While you may pay a fee to withdraw funds from retirement, the option is still there for a rainy day. You will need to refinance to access the funds you’ve paid into your mortgage, which may not be an option due to your financial situation and goals.

Saving up for retirement first

When it comes to saving for retirement, your greatest asset is time. The effects of compounding interest can produce much greater results the longer the accounts have to grow. By saving for retirement before getting more aggressive on your mortgage payments, you allow yourself to create a much stronger nest egg for your future retirement.

For example, let’s say you choose to wait on saving for retirement and don’t begin making contributions until you are 55 years old, which is 10 years out from the standard age of retirement. If you initially invest $10,000 into your account and contribute $500 month for the 10 years leading up until retirement. If we assume an estimated return of 6.5%, you’ll have $99,731 saved when you turn 65.

If you double the time to 20 years, though, and make the same initial investment and contributions, you’ll end up with $268,188 by retirement age. If you notice, this is considerably more than double because of the effects of compounding interest over time.

Now, you could make the argument that you contributed more money in the second example, which would be true. What happens if you increase the time (by starting to save for retirement first), but lower the monthly investment so that you contribute the same dollar amount?

In example one, you would contribute:

$10,000 + (12 months * $500 * 10 years) = $70,000

In example two, you would contribute:

$10,000 + (12 months * $250 * 20 years) = $70,000

Would the returns be the same? Not at all. Assuming the same 6.5% annual return, example one grows to $99,731. Example two, though, would grow to $151,712. By choosing to invest in your retirement earlier, you can take more advantage of the effects of compounding.

On top of this, choosing to invest in retirement first gives you added liquidity. If you ever have an emergency and need your money, you can get access to it quickly. Yes, you will most likely pay a penalty for accessing the funds early. However, in an emergency situation, that may be a cost you are willing to pay. 

The drawback to investing in retirement first is you’re leaving debt on the table with your mortgage. Unpaid debt that’s accruing interest costs you money that could be used elsewhere. The longer that debt is outstanding, the more in interest charges you will pay. Finding the balance of liquidity and saving can be challenging and is fully dependent on the details of your situation.  

Paying off your mortgage vs. saving for retirement

Your mortgage is a debt that you owe, and your retirement is an asset that you grow. Higher interest rates and returns for the lenders mean more costs to you over time. Higher interest rates and higher returns on retirement assets, though, mean more financial growth for you. In other words, the same forces that are working in your favor for retirement savings are working against you with your mortgage.

Calculating the effects of compounding can show you the benefits of saving for retirement earlier. To see the advantages of paying off your mortgage early, you may want to look into using one of the many online calculators to see the potential benefits. 

For example: You have a $200,000, 30-year-fixed loan with an annual interest rate of 4.5%. Currently, your monthly payments are $1,013. The total you are scheduled to pay over the life of the loan is $364,814.

You decide you want to make an additional $200 in payments toward your principal every month. Your monthly payment increases to $1,213. The total you are scheduled to pay for the life of the loan drops to $312,058, and the loan would be paid off in 22.5 years instead of the full 30. Even a few hundred dollars every month can have a dramatic effect on the cost of your mortgage.

Is it possible to pay off my mortgage early while saving more for retirement?

You may be wondering if this is a “one or the other” situation, or if you’re able to pay off your mortgage more aggressively while saving for retirement. The answer is most likely, yes. The best course of action is to map out your current financial picture, including all loan terms, your desired retirement savings goals and how much extra money you have to allocate to these different areas.

Remember, you have to make your minimum monthly mortgage payment regardless of your plan of action, so that is an automatic decision. Beyond that, you can begin to allocate funds to both buckets. Even small bumps in mortgage payments or investments into retirement can have dramatic effects over time. Deciding how much to put into each bucket will depend on the expected return from your retirement savings and the interest rates you’re being charged on your loan.

You will want to dedicate the larger sum of money to the bucket to the area where you will see the biggest dollar amount gain. That being said, a balanced approach to tackling debt while building savings is always best. Plan to put a percentage of your extra cash toward your mortgage and a percentage toward retirement savings. By taking advantage of time in both categories, you can achieve both goals simultaneously.