When planning for retirement, one of the biggest hurdles you’ll face is deciding whether to retire with or without debt. Debt can be a strong wealth-building tool, but it carries risks you may not want to have in retirement. However, determining its importance will ultimately come down to your risk tolerance and retirement goals. Today, we’ll explore the pros and cons of debt to help you decide if debt is suitable for your retirement.

When can debt be a good thing?

Smart people don’t use debt to buy things they can’t afford; they use it to build wealth. Most often, they take out loans to buy real estate. By borrowing money, they can purchase more properties than they could with cash alone, enabling them to scale their real estate portfolio quickly. It also allows them to put less money into properties to boost profitability. Hopefully, by using debt, an investor can create a cash-generating rental portfolio, one that is larger than those built without debt.

In retirement, most people’s incomes drop significantly. Having inconsistent (or less frequent) paychecks can be jarring to many. But if you own cash-flowing rental properties, the change would be less dramatic.

Should you pay off your mortgage before retirement?

Only you can answer this age-old question for yourself. Everyone’s retirement looks different because of varying financial obligations, age, health issues, nest egg, etc. But to help you answer the question, consider paying off your mortgage if:

You are risk averse (reluctant to take risks). The fewer expenses you have, the more stability you have. Additionally, you can consider any loan a negative return on investment. Paying off your mortgage guarantees that that negative return disappears.
You are more of a saver than an investor. If you tend to hoard cash in your bank accounts and lack investments, consider paying off your mortgage. As said previously, loans yield negative returns for you. Getting rid of the loan will result in a positive outcome.
You are unhealthy or elderly. When real estate is passed down to the next generation, sorting out who pays for the mortgage becomes a headache for the heirs. The heirs may be forced to sell the home if they cannot pay the mortgage. If there are multiple heirs, what happens if one heir can pay their half of the mortgage but the other cannot? Things can get ugly quickly. On the other hand, a free-and-clear property makes many of those pain points go away.

However, keeping your mortgage in retirement is not a bad decision. Mortgages are fixed expenses that are very predictable. Come tax season, if you itemize your deductions, you can continue to include your mortgage interest. Lastly, assuming your interest rate is relatively low (I’d say somewhere in the 3-4% range), investing your cash into the stock market rather than your mortgage would average a higher return on investment.

Why is debt bad in retirement?

I won’t discuss why carrying high-interest debt, like credit card debt, is bad. I assume most of my readers know that already. Instead, I will talk about the negatives that specifically impact retirement.

Lower income in retirement, harder to qualify for loans
Legal responsibility to continue paying the lender
Risks - passive income from investment property may turn negative during retirement and eat into your income
Peace of mind

1. Difficulty qualifying for loans

When traditional lenders test if a client qualifies for a loan, they primarily focus on their debt-to-income ratio. That is, total monthly debts divided by total monthly income. The lower your ratio is, the easier it is to qualify.

Simply put, the more debt you have, the higher your ratio is. Similarly, the lower your income is, the higher your ratio is. And the converse is true. So when retirement comes, incomes typically drop significantly. This instantly increases their debt-to-income ratios, which is why qualifying for loans in retirement is more difficult.

2. Legal responsibility to lenders

Upon your passing, your debts will continue to belong to your estate, which means that your surviving family members will continue to be responsible for paying your debts. Yes, they’ll also inherit your assets, which, hopefully, are higher than your debts. However, if you were the primary person responsible for handling debts and your surviving family could not take over, your debts could quickly become a burden for them. This scenario is far from ideal. If this sounds like your situation, perhaps it would be wise to sell off your assets to get as close to debt-free as possible before your passing to unburden your surviving family members.

On the other hand, inheriting a cash-flowing real estate portfolio can be quite fruitful if the surviving family is well-prepared to take the reins. Deciding to burden or unburden your surviving family with your debts comes down to each unique situation. Ask yourself if they know how to manage real estate well, if you can cleanly divide up your assets or if it’ll cause familial infighting, and, lastly, if you think passing on the burden of managing real estate will be worth their time and money.

3. Risks of holding debt in retirement

Even if your rental properties are cash flow positive going into retirement, many things can go wrong with rental properties. To name a handful:

Physical damage can be inflicted upon them, whether by bad tenants or natural events
They age over time, which means that maintenance costs go up over time, as well.
You can be sued by a tenant or buyer of your property, which could wreak havoc on your finances.
Tenants can stop paying at any time.
The rental market may slow, reducing your profitability or dragging it down into negative cash flow territory.

As with everything, you must plan carefully to avoid or reduce these risks well in advance! I doubt you want to deal with any of these things when you’re supposed to enjoy retirement.

4. Peace of mind and my retirement debt plan

Should you focus on building wealth when in retirement? While the answer is subjective, the answer for me is no. In my opinion, retirement is about living without worrying about money. That’s not to say that budgets go out the window. No, money will always remain a factor, regardless of your wealth. However, I believe in retiring only when enough wealth and passive income have already been built, not after the fact.

Of course, some individuals will have such a significant amount of wealth in retirement that accumulating more debt to build wealth is not considered risky. But that situation is not the norm. For most of us, acquiring hundreds of thousands of dollars in debt means many more years of monthly payments to a lender before becoming truly debt-free.

Personally, I would love to be debt-free when my partner joins me in retirement or within a few years after that milestone. I’d love to have peace of mind, knowing I don’t have to worry about another monthly payment to a lender.

Share below what you plan to do with your debt before retirement!

Pros and Cons of Retiring With Debt