Cash out small 401k to help pay down mortgage?

In reply to trucke :

WTF is that graph even trying to communicate. It's a marketing graph, not actual numbers. I could draw a line from 0 to 2.5m and say "my awesome advice" and have it be just about as useful.

Teaching debt elimination classes and you're pro-debt elimination - not a shock. I agree eliminating "bad" debt is very, very good and your average person needs that advice. But optimizing returns on investments is not something the average person is worrying about.

Numbers show that if you're returning more than 4% on an investment then paying off a 4% loan is going to earn you less money than investing the money. It's shockingly simple math and five minutes with an Excel spreadsheet can show you the results. I made that decision over a decade ago and just from my taxable account I could pay my mortgage balance off over twice now. Yet I keep the mortgage. Why? Because the money I would send to the bank is instead making me more money than the bank is charging me to use it. Even with the downturn this year I'm way in the green compared to paying off the mortgage.

I believe the OP has what he needs. 

The confusion comes in with compound interest.  It works differently when you are paying it than when you are getting it!

I'm not here to change anyones retirement strategy. Mines working great!!

In reply to Steve_Jones :

Yes. 2 of them actually. I did overpay on both monthly when they were in the 7% range but once I got that dropped to 2.6% on one and 5% on the other, I just made payments. Now own both and shopping for a 3rd sometime next year. 

If they are that worried about the future, put extra money into an investment account and sit on it as an oh beep fund. Then if they don't need it long term then more for retirement. 

Something to keep in mind is that the one thing in life you cannot borrow money to do is retire.  That 401(k) is there so that when you're too old to work any more you don't have to live off whatever tiny scraps of social security are left.  It's tax deferred and it's protected against creditors.  If bad things happen and you have to declare bankruptcy and the house is foreclosed then you still get to keep the 401(k).

dculberson said:

 

Numbers show that if you're returning more than 4% on an investment then paying off a 4% loan is going to earn you less money than investing the money. It's shockingly simple math and five minutes with an Excel spreadsheet can show you the results. I made that decision over a decade ago and just from my taxable account I could pay my mortgage balance off over twice now. Yet I keep the mortgage. Why? Because the money I would send to the bank is instead making me more money than the bank is charging me to use it. Even with the downturn this year I'm way in the green compared to paying off the mortgage.

Out of curiosity - what are you assuming happens to the mortgage payment money every month after the mortgage is paid off?

Not sure how this part fits in, but I find it helpful. Home buying is sold as an investment. And it ONLY is that when you sell it. 
 

If you buy a home, and never leave it, you will never see the returns on the investment.  Also, flipping homes can be tricky, too, since so much interest is paid early on. 
For us, while the value of the home has tripled since we bought and did work, I don't see us moving, so all of that value isn't going to be seen by us.  Heck, even if we do move, all other properties have gone up, too- and we will always need a place to live  

The point I'm trying to make is that you have to be honest and realistic with your assumptions going into the math. Not only does that apply to moving, but future expenses (kids), job prospects (can you max a 401k contribution?), etc. 

And for that, I would run multiple models instead of wrapping it all into one. 

I'll throw down a reason to pay off the mortgage/debt; I sleep at night.

In the 80's we qualified for a$200,000 loan with both working.  We went way less and borrowed $65,000.  Wifey blows out gallbladder and she missed work then she got pregnant.  Our plan was to not max out our life.  We paid the mortgage off and all is good to now invest.

Another consideration is that many public retirement systems pay out for the life of the recipient. 

It might be worthwhile to ask what her projected monthly benefit might be if she "retires" from the system at 55 or 65, then project the gross from there.  $17k might be worth considerably more than that if you leave it alone.

Duke said:

Out of curiosity - what are you assuming happens to the mortgage payment money every month after the mortgage is paid off?

 

I assume it would be invested, but you still end up with less money. Think of it as arbitrage; you're borrowing money at one rate and investing it for another. If the investment returns more than the loan you've gained. Over a 15 or 30 year period you will gain more than 4% a year on average, given any reasonable investment portfolio.

As a concrete example, say you invest the $17,000 in question into any of the low fee S&P500 index funds out there. On average over the last 100 years the S&P index (not originally 500 stocks, started as 92) has returned 11.82% annually. The Vanguard S&P 500 EFT charges .03% so your total return could average around 11.79%. Over 15 years that would make your $17,000 into $90,468.

Compare that to paying the penalty and taxes and netting $13,500 and OP says they would. You apply that to the 4% mortgage. After 15 years how much has that saved you? $10,812 in interest, for a net asset value of $24,312 on your balance sheet.

Now, I don't know which scenario you would choose, but if it was up to me, I would rather have a $24,312 mortgage balance and $90,468 in a 401k versus zero mortgage and zero 401k. That is what I have chosen, and it has worked out resoundingly in my favor so far. Actually, even better as the market went kinda nuts for a while there.

This example ignores the effect of any additional payments or investments, but if you start adding money in it makes the investment side of things work out even better for you.

In reply to dculberson :

I'm not in any favor of cashing out the investment.  Ignore that scenario.

I'm talking about a regular mortgage and regular payments.  Say you have a $150,000 30 year 4 % mortgage and from payment #1 you add enough principal every month to pay it off in 20 years.  That's very doable.  You'll save a lot of interest.  You also get 10 years to invest all of your mortgage payment without changing your monthly costs (albeit 20 years in the future, rather than less but sooner / longer).

I'm genuinely curious about how the math pays out versus putting the equivalent extra money into an S&P Index fund every month as you say.  Unfortunately I don't have the time to dive into Excel and figure it out.

In reply to Duke :

If the investment rate is the same, it comes out the same. If the investment rate is greater, the investment comes out ahead. If the mortgage rate is greater, the mortgage comes out ahead.

Compound interest is simple math. It works exactly the same for each dollar involved, regardless of whether it's being applied to a debt or an asset. The only real difference is that mortgages are advertised at an APR, where as many assets are advertised at an APY. This leads to a fraction of a percent difference annually, due APY adding in the monthly compounding. So if you're comparing putting extra funds into paying down a 4% APR mortgage vs putting those same funds into a 4% APY CD, the mortgage would have a 0.07% annual advantage.  But run true equal rates (APR=APR or APY=APY) and get equal results.

In reply to Driven5 :

Except he's saying an S&P Index fund will return ~11% APY.

It's also about the varying relative rates of investment.  It's not unsolvable.  It's just unsolvable given the amount of free time I have to fool around in Excel.

In reply to Duke :

What I described inherently accounts for the 'varying relative rates of investment'.  It doesn't matter if each $1 is being applied to paying off a debt or increase an asset: If it's at the same APR/APY, then it has the same net effect on your overall long-term financial picture.

So like I said, if the S&P returns any amount >4% over a given time period, then it will have an equivalently greater ROI than using that same money to pay down a 4% loan. It has already been validated many times before by many people, myself included. With the assistance of a mortgage calculator, it's actually pretty quick/easy.

In reply to ProDarwin :

It's that freedom to take a lower paying job or even no job that having no debt brings. Sure you might make more for retirement but what good is it when you spend your entire life stressed?

People that think you should pay off the house will never convince those who think you shouldn't, and vice versa. I do know you can amass a large amount of cash, if you have no debt, maybe it's just easier for people that think that way to do it, vs those same people paying themselves first, who knows? Some people just sleep better knowing no matter what happens, their nut is really low, some people sleep better knowing they have a lot in savings. 

bobzilla said:

In reply to ProDarwin :

It's that freedom to take a lower paying job or even no job that having no debt brings. Sure you might make more for retirement but what good is it when you spend your entire life stressed?

Again, I'm not judging the emotional side of this, but you are recognizing that its emotion driving that decision, not math.

Regarding freedom, my savings is what allows me to have that type of freedom you describe.  You don't necessarily need zero debt to be free.  At any moment if I decide zero debt is an absolute priority, I can pull cash from my investments and pay off my mortgage.

In reply to Duke :

Ok, here we go. Let's assume you take out a $100,000 mortgage in December 2022 at 4% APR, but also have access to a monthly compounding ROTH investment account at a fixed 4% APR.  

Scenario A) In January 2023 you have an extra $1 that you don't know what to do with. If you put it towards the mortgage, your last payment in December 2052 will be $3.3o less than usual. If you put that into the investment account for an additional month, you'll end up with $3.31. If you just put that $1 into the investment account for 30 years instead, you'll end up with $3.31.

Scenario B) In January you have an extra $1,000 that you don't know what to do with. If you put it towards the mortgage, your last payment will be in June 2052 for 71.58, more than 6 months ahead of schedule. This leaves an extra $414.02 in your pocket for June, plus an extra $477.42 per month for the subsequent 6 months. Reinvesting that into the investment account each month leaves you with $3,302.52. If you put that $1,00 directly into the investment account for 30 years, you'll end up with $3,302.49.  Outside of a statistically insignificant $0.03 due to minor rounding effects accumulated over a 30 year period, there is zero difference when given the same rate.

So while both are certainly better than doing nothing with your extra money, and far better than spending it, if you're looking for the better ROI it's literally a simple matter of which ends up with the better equivalent rate and by how much. If you invested the $1,000 in an S&P fund through a ROTH account that averaged 8.3% annually (8% APR equivalent) over those 30 years, you would end up with $10,863.31 in addition to the paid off house.

In reply to ProDarwin :

We already had the savings, cash nest egg and maxed retirement funds. Going debt free allowed the wife the option of getting out of her high stress position and go someplace where she can enjoy her life. That's a bit more than emotion. That's life expectancy extending. That's a quality of life change. And it's a health improvement. To classify it as an emotional response is a bit simplistic don't you think?

Someone referenced the current economic state earlier, so I will follow up on that:  

If we were in a more stable economic environment with very minimal inflation, then I don't really think that this would be much of a discussion within the household.  

No. Never cash out retirement funds except to avert a foreclosure or bankruptcy. 
 

Ultimately, you want a 6 month emergency fund in savings, a large sum of money invested, and no mortgage payment. Balance your priorities with those goals in mind. Limit your retirement contributions to 15% of your income and pay extra on the mortgage. The goal being to payoff the house in roughly 10 years. Once the home is paid off, you max out all retirement investments plus other investments.
 

Full disclosure, we are not quite there yet. We are about 3 years out from paying off this mortgage.  This is our second house, and we moved here roughly seven years ago. 
 

In reply to Driven5 :

You are leaving out the risk in your assessment. When comparing two investments in the market you use the beta as part of the formula. The beta is a measure of volatility and risk. It allows you to compare a modest but consistent return investment to a volatile but seemingly high return investment. Often the consistent investment wins. 

You are also missing the human factor, a person without a mortgage can make much different career and investment choices and make a lot more money. A desperate person often makes poor decisions. 

In reply to Driven5 :

Thank you for the math. Real question: does your scenario C account for the extra mortgage interest paid?  I assume it does.

In reply to tester (Forum Supporter) :

He's acknowledging the human factor.  He's just disregarding it and speaking to pure math.

Let's throw some numbers out. 

Option 1: Pay off mortgage faster and then save.

I'm using Duke's suggestion of $150k mortgage, 30 years, fixed at 4%.  Payments are $716/mo.  If we want to retire that in 20 years instead of 30, we need to add additional principle payment of $200/mo.  So in 20 years mortgage is paid off.  Mortgage interest payments total $67K.  This saves $41K in mortgage interest charges.  

Now we have the mortgage payment of $716/mo plus the additional $200/mo.  This gives us a lot of options for our lives.  However, using the original 30 year window, we now have 10 years to invest.  Investment amount is now $916/mo.  At 4% we can accumulate $134k in 10 years.

Option 2: Pay off mortgage in 30 years and save $200/mo.  

Make regular mortgage payments.  Save $200/mo for 30 years at 4%.  This generates $137k in investment.  So this is about $3k higher than paying off the mortgage faster.  Mortgage interest payments total $108K.

Notes:

•  Paying off mortgage faster gives piece of mind.

• Paying off mortgage faster is guaranteed savings.  Yes, guaranteed!  You do not have to pay the interest charges that you were obligated to do when you signed the mortgage papers.

• The investment amounts are not guaranteed.  The rate of return is dependent on many factors beyond our control.  

• Disregarding any mortgage interest saved since at the end of 30 years, the house is paid off, and investment income has been accumulated.

End result: Each of us must pursue the best direction for our situation and how much risk we will take.