Jim (a regular reader of LifeAndMyFinances) and his wife (Mrs. Jim) absolutely hate their home mortgage. If they had the cash to pay off their bank right now, they would absolutely do it without hesitation. Unfortunately, they do not have $47,000 in cash to do this right now (no big surprise here – that’s quite a lot of money!), so they are considering taking out a loan from their 401k to pay off that nuisance of a mortgage. What do you think, should they do it? Before you answer too quickly, let’s dig into some details as well as the positives and the negatives of taking out a 401k loan.
The Situation
Jim and Mrs. Jim are in their mid-50’s with about 10 more years of work ahead of them before they retire. They have a 401a account (which is very similar to a 401k) that’s beefed up with $950,000, but still have $47,000 of debt to pay on their mortgage. Today, they are considering taking out a loan against their 401k for the following reasons:
I commend Jim and Mrs. Jim for even thinking about what might be wise for them in the present and in their future. Many people just go through life accumulating stuff and never even think twice about how it could impact them or their future retirement. I understand the fears and concerns of a house mortgage and the state of the economy, but are these fears leading Jim and Mrs. Jim to a positive response or a crippling reaction?
The Pros and Cons of Paying off the Mortgage with Your 401k
Many people consider withdrawing money from their 401k and just elect to pay the penalty. This is quite obviously a bad idea. But what about borrowing money from your 401k? Is this a wise idea for paying off debts and putting yourself into a better financial position? Let’s take a look!
The Pros
The Cons
The Decision – Asking for the Readers’ Advice
When it comes down to it, Jim and Mrs. Jim are sick and tired of the market rising and falling, and they just wish that their mortgage was completely paid off. While it is difficult to put a quantitative measure on emotion, I totally get where they are coming from! After all, I am currently in a fierce battle with my mortgage and am trying to pay it off as soon as possible. The feeling that I will get once that mortgage is paid off will be priceless, and I absolutely can’t wait to accomplish it!
The big looming question at this point however, is whether or not Jim and Mrs. Jim should borrow money against their 401k to pay off that remaining mortgage balance of $47,000.
So what do you think? Should they use the 401k loan to pay off the mortgage? Or are there some other options that you can think of? Please help Jim and Mrs. Jim by leaving your comments below!
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.
26 Comments
Absolutely not! With 10 more years to work and such a small balance they can be rid of the balance very quickly. They should rework their monthly budget and find extra to apply to principle. We are striving to eliminate our mortgage on a fixed income and manage almost $600 extra a month to rid ourselves of the beast.
Well that was quite the blunt answer JD. ? What if you knew that the stock market was going to plummet 20% tomorrow? Would that change your answer?
No, my retirement monies are in the stock market and I don’t try to time it. I have been reading for the last 6 years that it is going to take a significant haircut. It probably will, housing could collapse, whatever, I stay put. My retirement fund yields well and I am not real worried either way. Sorry that I was so blunt but how would you prefer I say it?
What if he has a heart attack and can’t work? What if his job ends? How does he pay it back? I don’t think it is a well thought out solution to a very reasonable balance to be paid off. Too blunt?
I absolutely love blunt JD. Well said.
Yes, it would be fine to borrow money from your retirement accounts to pay off the house. The reason I say yes is below. For a lot of people peace and mind goes a long way and I would love to personally not have a mortgage. So for me it would be the peace of mind that comes with the whole thing. The couple with almost a million dollars are obvious savers and repaying the loan I would image would be no problem. Without having a house note the couple could actually repay their retirement accounts back a lot quicker.
A couple of other options they have since they are getting close to retirement are: Sell the house, downsize and rent a smaller house or apartment and invest that money in stocks, bonds, gold, silver, land or they could move across town and purchase a smaller house. There options are really almost limitless. Without all the details on Mr. and Mrs. Jim the real answer would be nobody really knows. If they are looking to move to Florida maybe they sell there house, buy a smaller house or condo and rent it out to snow birds, thus making income from there place and make money renting there new place. By doing so that will help them get whichever they want to go a lot faster in life. If they stay in the house then they may have a harder time selling it because they will say the kinds grew up here, etc. etc. but if they take the stance we want to move somewhere one day then why not wait and sell your house, buy a smaller house, rent it out and give yourself a goal to be in your dream location at a certain time. Also if you were not in a hurry to move you could look for a short sale, foreclosure or great deal being that you are in no hurry to move. Like I said it all depends on their goals.
Derek,
Thanks for posing the question.
JD,
Thanks for the honest response. Love your passion. However, I’d like to address the points you raised and see if you think I’m missing anything. First, we’ve been throwing an extra $2700/month at the mortgage (for a total of $4K/month) since January, 2013. Second, we’ve gone thru 2 major market crashes and wife has no more stomach for that – not when what we lost would have paid off the mortgage. Third, if I have a heart attack, I may be dead in which case she gets the life insurance policy. If, however, I survive, but can’t work due to a disability, I’ve got long term disability insurance. Fourth, if I lost my job (highly unlikely since I’ve been there for almost 30 years) I could tap my other retirement funds (penalty and tax free given the separation from work) and immediately pay back the loan (which will be paid back in a year anyway).
Meanwhile, I have a very happy and contented wife whose house is paid for in full and I don’t have to worry about us losing $50K in the market and have her look at me again with that “we could have had this house paid off – again” look on her face. Hmmm….. comments? Thanks.
As far as I can tell from what you have said your course of action is decided. It is fine with me that this makes you both happy. I still see it not gaining anything except your mortgage is paid off and now you repay your retirement account. Having said that, the choice is yours and always has been.
I agree with JD. Keep paying the extra $2700/mo towards the mortgage. At that additional payoff, you should have it paid off relatively quickly. If you are that concerned with the market dropping, you should review your asset allocation and dial it back so that you can sleep better at night.
JD,
You see our approach as nothing other than “your mortgage is paid off”? Well, if that’s not a big deal in your world then I understand where you’re coming from. To us, it’s huge.
Jon,
We have re-balanced our asset allocation and are happy with where they are at. I find it interesting that neither you nor JD addressed the specific points I raised. I suspect neither of you have ever put a kid (or two or more) thru college debt-free and hence you lack the experience and wisdom of having done so – no offense intended, I’m just guessing this is your guys’ life experience at this point.
Tim,
I’m with you. Peace of mind is priceless. Really, how much could we possibly make (or lose) with that $47K in the market that could possibly beat out the contentment and happiness this will bring my wife. Money isn’t everything and given that we could retire quite happily today and live very well from here on out on our investments, I’m just not seeing the benefit of having more $ in the market while we could have NO MORTGAGE.
Thanks to all for your input. I appreciate it (even if I don’t agree with most of it). It’s interesting to hear other’s input and I do thank you for taking the time to do so.
Hi Jim,
I actually agree with the others as well. I get the whole peace of mind thing with getting rid of that mortgage payment, but I don’t fully understand doing it by borrowing from your 401k. You’ll still be making mandatory payments, but you’re increasing your risk should you lose your job or decide to switch companies (and have to pay the lump sum back immediately). I know it’s improbable, but it IS possible, which is increasing your risk quite severely when compared to making mortgage payments. I say stick with the house payments of $2,700 a month. That mortgage will be long gone two years from now and you won’t have to worry about it ever again.
Derek,
I appreciate the input. I’ll share everyone’s comments with my wife and see if it changes her thoughts. Thanks much.
Ultimately, it’s your decision Jim. We have out opinions and you and your wife have yours. Emotions can be very powerful, and if getting rid of that mortgage outweighs the other points given here by the other readers, then you know what you should do.
An extra $2700 a month is a lot and will have it paid off quickly. Life always has what-ifs. I could get hit and die in my car tomorrow. I’m surprised that someone with nearly a million dollars in retirement doesn’t have that much cash on the side to pay it off. It is your money so you can do what you want with it. Sounds like your mind is already made up so might as well do it and then apply the extra $2700 + mortgage back to your retirement to get it back to where it should be.
Lance,
Thanks for the input. I, personally, don’t have my mind made up – but I’m pretty sure my wife does – ha! I’m curious, though – what do you mean “get your retirement back to where it should be”? We’ll still be contributing to our retirement funds just as we always have while we pay off the loan (assuming she wins the argument) and the loan will be paid off in about a year (or less) so we wouldn’t be losing too much “opportunity cost”. Once that year comes and goes, we’ll be able to throw an additional $4k/month in various retirement accounts – which will get us up to that $1M in cash (or cash like investments).
Absolutely do not borrow from your 401k to pay off your mortgage. Since the loan is not for a purchase you will have to pay back the loan in 5 years or less and you will forego any potential gains on the amount taken from your account. Something else to think about, you will be paying your loan back with after-tax dollars which will reduce your take home pay. Worse yet, you will be paying tax again on those loan payments when you withdraw those dollars in retirement.
Paul,
Thank you for your input. This is the “Mrs.” speaking now – hell, I have to after all the ammo you guys have given my husband (kidding – sort of :))
1). We are going to pay this loan off in 1 year – yep, 12 months. Therefore, I am not concerned about “potential loss of gains” that a mere $47K may cost us.
2). We’ve got almost $1M already saved for retirement.
3). We lost our asses TWICE – HUGELY in the market before. That could happen again and I swear if I see our losses go over what we could have had this mortgage paid off with again I’m going to scream.
4). We are otherwise completely debt-free, our kids our grown and college educated (also debt-free).
5). I’m damn sick and tired of having a fricking mortgage.
6). We will still be contributing to our retirement accounts – just as we always have to the tune of $3K/month.
7). After we pay this loan off in 12 months, we will then have an additional $4k/month to invest – conservatively, while, IMHO, the market tanks (at least potentially).
8). Once the mortgage is DEAD I really won’t care that much if the market tanks. I will then be able to see it as a “buying opportunity” and hubby can do whatever he likes in the market without my watching every little blip on the graph/market.
9). We’ve still got 10 years before retirement – so there will be plenty of time to “finish off our retirement savings”.
Last, but certainly not least, I want the peace of mind that will undoubtedly come with NO DEBT INCLUDING NO MORTGAGE.
Now I will grant you that I appear to be making my case to all guys (and probably much younger guy than me for the most part), so I would ask you to run it past your girlfriends/SO’s/wives – whatever – anyone of the female persuasion AND anyone of a certain age who has put their kids thru college, paid for a wedding, bought kids their cars, helped with a down payment on their first house, etc ALL so that they don’t have to do what we did when we started out. Absolutely no regrets having helped the kids – we wanted them to start their lives debt-free – MUCH UNLIKE we did. But that has given me a taste to detest debt of any kind and I, personally, would gladly pay any “lost opportunity costs”, taxes etc to wake up next week knowing that our mortgage no longer existed.
Gentlemen, kindly run this past some women and older people and then address my points. My husband thinks you’ve almost got me convinced not to take the 401 loan. I remain unconvinced.
That said – we both really do appreciate everyone’s input. It’s great to get other’s points of view and I’m up for a lively discussion pretty much any time.
Hi Mrs. Jim. The one thing I would hate to see happen to you is a mandatory full payment back into your 401a due to job loss or job change. If you cannot pay it, then the money will be pulled from your retirement account, taxed, and penalized! Have you ever considered stopping your contributions and just dumping $5,700 a month toward the mortgage? This is effectively the same thing (since you are taking money from your 401a to pay the mortgage loan), and at a lower risk.
Derek and Mrs. Jim,
This would be the better option if you decide to move forward given the fact that you would be repaying your 401k loan with post-tax dollars and you will pay taxes again when you withdraw funds later in retirement.
Mrs. Jim – Sounds like you’ve got your mind made up. I can’t address the peace of mind argument but I can tell you no one knows what the markets will do. In the end you and your husband will decide what is the right decision for you. I personally would never take a loan from a retirement account unless it was under a hardship condition.
Derek,
Thanks for the thoughts, but you are mistaken re: if there were a mandatory pay back due to a job loss or change there is NO penalty or tax due to a separation from work, the loan simply becomes due – period. At least that’s the way it is under my plan. As for just stopping the contributions temporarily, we’d be losing the employers’ matches so it’s actually “cheaper” for us to continue with the investments while we pay the loan back.
Paul,
You’re exactly right – no one can tell you what the markets will do. I’m willing to take a year long “risk” that the market continues to go strong and we lose out on those potential earnings for the security and peace of mind of having the mortgage paid off sooner.
Appreciate your guys’ input. It’s been a great discussion.
Is the biggest issue the worry of having a $47,000 debt or the payment that comes with it? I am wondering if there is another solution.
What if you refinanced the $47,000 (I am guessing at a lower rate then you have now unless you recently refinanced). There would be some pros and cons to this.
1. lower interest rate meaning you pay off the debt sooner
2. Much lower payment in case you want more flexibility and the payment is what scares you.
3. You can still pay as much as you want extra in to the loan to pay it off quickly.
4. If you lose your job you don’t have to repay anything, in fact you will have a much lower payment to work with if you need extra money.
Cons
1. you have to pay closing costs for a refi. May be $1,500 on a loan that low. If the interest rate is a lot lower that may make up for this.
2. you extend the life of the loan, but you can still pay it off quickly.
I’m think about actually withdrawing my entire 401k amount to pay off my mortgage. At this time I have about 200k in my 401k and owe about 160 on my 15yr mortgage. Based on my current salary I can only put 6% in order to gain the company match and still pay my mortgage and other bills. I feel that if I paid off my mortgage and I would have to start my 401k from scratch but I could put 18-20% into my 401k. I know that I’d be paying a lot on taxes plus the extra 10% penalty since I’m only 40 but I feel long term I’d be better off since my taxable income would be lower due to the additional money I’m putting into my 401k, I don’t really get a tax break on my mortgage interest because my rate is low. I’m actually better off taking the standard deduction.
To be honest with you Al, nothing about that plan sounds good to me. Even if you withdrew 100% of your 401k, you still wouldn’t be able to pay off your mortgage. With the withdraw, you’d have to pay the 25ish% tax, and then the 10% penalty. After the full withdraw, you’d be left with $130k. So, even if you put it all toward your mortgage, you’d still owe $30,000 and would still be stuck contributing only 6% to your 401k.
Al, you already made a good move by going with the 15 year mortgage. If you really want to pay it down, I’d find another way to do it. Either increase your earnings or decrease your expenses. If you need some ideas, let me know!
Thanks for the response Derek. I forgot some details. I also own some land in Puerto Rico that I am selling. I feel I’ll have an additional 50-60K from the sale. That would allow me to pay off the house. Also, my mortgage is at 3.25% so I don’t really get the tax advantage from it. I ran some 401k projections on http://www.bankrate.com/calculators/retirement/401-k-retirement-calculator.aspx and found that the difference between continuing on my current path and only being able to sock away 6% of paying off the mortgage and saving 18-20% is about 300K, which is about the value of my home. Again, I mention by putting away such a sizable rate into my 401k that would lower my taxable income and I can still take the standard deduction which is more than what I can currently get by itemizing my taxes right now. My other concerns are though I know that I need money in the future and I’m relatively healthy are any of us guaranteed to live a long life? I feel that I’m missing out on enjoying more of the here and know because I’m worried about a future I don’t even know I’ll be around for. I’m still just thinking about it doing this since I’m currently employed with the company and would have to quit and get a new job in order to cash out my 401k. Again, I appreciate the response and insight.
I’m still not a big fan, Al, especially since your interest rate is so low! Perhaps there is an Option C? Sell your Puerto Rico land, sell your home, and purchase a smaller home with cash! To do this, it may need to be a fixer-upper, but without a mortgage you could easily put a few bucks into it each month as you redo some floors and paint the walls. Do you think this would be an option? I would just hate for you to forfeit $20,000 in penalties. That just doesn’t make much sense no matter how you slice it.
Thanks for the response. I’m going to think about it and weigh my options.
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