What is the real cost of a mortgage during retirement?
The cost of a mortgage payment during retirement depends on your personal Tax Hump
situation. The following is an example of a $1,300 monthly mortgage payment made
by an individual who retired at age 66 with an average inflation adjusted working
income level of $70,000. Their State tax rate from $20,000 to $100,000 is 4.75%
and their local tax rate is 3%.
Their $1,300 monthly payment is composed of $1,000 for principal and interest and
$300 for taxes and insurance. They can reduce their after tax income by $1,000 a
month or $12,000 a year if they can eliminate their mortgage payment.
The cost of the extra $12,000 each year for
the principal and interest on the mortgage is actually $17,374 taken from your IRA
account. Your marginal tax rate on that extra income will be 30.93%. The same
$12,000 at the 22% Federal Tax rate would only cost $15,385, almost a $2,000 annual
savings.
These numbers were created using the spreadsheet supplied on this website which
does not include state and local taxes, so I added a couple of extra cells on my
copy of the spreadsheet to make the adjustment the extra taxes. My final result
was that getting the extra $12,000 necessary for the principal and interest portion
of the mortgage payment required an extra $19,291 withdraw from your IRA with a
total Federal, State, and Local tax of $7,291 for an overall marginal tax rate of
37.8%.
If you divided space in the graph between the solid green taxable tick mark and
the dotted green + TI (Taxable Income) tick mark into 12 equal spaces for each of
the 12 monthly mortgage payments, it is easy to see that each payment happens as
a different marginal tax rate on the solid red line. Here is a table that illustrate
the cost of $1,000 after all taxes at various Federal Tax rates plus the state and
local tax rates from this mortgage example.
What is the pretax cost of a $1,000 mortgage payment? 
$1,000  While working 
Marginal taxes during retirement 
Federal  22.00%  24.00%  22.20%  49.95% 
40.70%  22.00% 
Fed Cost  $1,282  $1,316  $1,285  $1,998 
$1,686  $1,282 
And if you include 8% combined State and Local taxes! 
Total Cost  $1,429  $1,417  $1,433 
$2,378  $1,949  $1,429 
Savings  $0  $42  $4  $950  $521 
$0 
If you are NOT facing a sizable Marginal Tax Hump, paying off your mortgage early
will have little value. If however you are facing a sizable Marginal Tax Hump, paying
off your mortgage early could save you thousands of dollars each year!
