Cash out small 401k to help pay down mortgage?

bobzilla said:

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?

Agreed those are not emotional things.  But the emotional response to being debt free is what allows for that.

The saving scenario also allows for all of that, but it doesn't come with the warm fuzzy you seek.

Will they let you pay a couple payments in advance ?

then you have a little security if something comes up in the future and still keep the 401k.

In reply to californiamilleghia :

No. Mortgages generally don't work that way. If the lender receives a payment in excess of the amount due, they apply it to the principle at the time it is received. They don't have the ability to hold some money until a future payment is due. 
 

But you can always put it aside yourself. 

SV reX said:

In reply to californiamilleghia :

No. Mortgages generally don't work that way. If the lender receives a payment in excess of the amount due, they apply it to the principle at the time it is received. They don't have the ability to hold some money until a future payment is due. 
 

But you can always put it aside yourself. 

+1

When our back operated under its old name, we had worked up to 2 months ahead on payments in their system.  To be clear, their system right now would show that our next payment would be due 3/1 instead of 1/1.  When it merged and changed names, we lost that advantage and their system has been a pain in the butt.

trucke said:

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.

You're comparing a guaranteed 4% return via early mortgage payoff to a potential 4% return via savings or investment. Obviously if the rate is the same, or even pretty close, then it makes sense to take the guaranteed return.

What others are saying, is that average stock market returns have historically been 7-8% over a 30 year period. So the choice is between guaranteed 4% payoff with the mortgage given in the example, and a potential return of quite a bit more than 4% via investment.

Here's the math using historical average returns of 7% for any money invested:

By paying 4% loan off early, you save $41k in interest. You then start investing the full amount previously applied to the mortgage and build up $158k over years 20-30 (assuming 7% return). So your total impact is 41k not spent on interest + 158k cash in an investment account = 199k net benefit via early payoff and then investing @ average returns.

If instead of putting that extra $200/mo into the mortgage you invested it into an index fund that was able to meet historical averages of 7%, you'd end up with $245k in investments after the same 30 year period. That's $46k more than the net benefit, and $87k more than the cash investment balance. That's a 19% increase in assets after 30 years (assuming money not spent in interest is the same as cash on hand, which may be a bit dubious). If you're just comparing the cash balances of each investment account, then paying off early leads to 34% less total assets after 30 years.

With current mortgage interest rates between 6-7%, (much closer to historical average returns) the guaranteed return of paying down the mortgage become more appealing. But for anybody that's got an interest rate below 5% they'll probably come out with a decent amount more money after 30 years by investing any extra money rather than putting it towards additional principal payments.

In reply to STM317 :

You are correct!  We are discussing only a mortgage debt.

Unfortunately, many people have school loans, car loans, credit card, medical payments, mortgage.  When you look at a debt-free strategy in those scenarios, the numbers will show debt-elimination as the clear winner. 

trucke said:

In reply to STM317 :

Unfortunately, many people have school loans, car loans, credit card, medical payments, mortgage.  When you look at a debt-free strategy in those scenarios, the numbers will show debt-elimination as the clear winner. 

 

... for the high interest loans out of the bunch.

tester (Forum Supporter) said:

In reply to Driven5 :

without a mortgage can make much different career and investment choices. ^

^ This

I'm 58 and I mentioned that I paid off my mortgage last May earlier in this thread.

My loan was a 30 year fixed at 3.625% and the S&P 500's long term average rate of return is about 10.8%.

Simple math sez' I made a poor financial decision but here's why I did it anyway...

I plan to retire in four years or less and any mainstream financial advisor would tell me I need to have at least 20% of my portfolio in bonds at this point.

I have zero, nada, zilch bonds and I don't plan on ever having them.  I've spent my life being medium aggressive with my investments and at this point, even if the stock market really tanks, I'll still be waaay ahead of where I would have been had I followed conventional guidance.

tester (Forum Supporter) said:

You are leaving out the risk in your assessment...

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...

I didn't leave it out, I equalized it. The only way to get a direct (true apples-apples) comparison is for both vehicles to have Beta = 0, so similarly risk free guaranteed returns. Expanding that to the S&P made it Beta = 0 @ 4% vs Beta = 1 @ 8%. What that means is up to each individuals risk tolerance, but consider that there has NEVER been a 20+ year period in which the S&P did not exceed 4% annualized return.

If you're not taking a higher paying job because of your mortgage, that implies it has low job security and you should probably be putting the extra in 'cash' (savings/money-market) accounts rather than either a mortgage or a retirement fund. If it's so that you can take a lower paying job or retire, then as noted by ProDarwin, the same gets accomplished through the investment route and using the account balance to equivalently supplement your income.

IMHO: At 2-4% there is no significant incentive to ever put even a single extra cent towards my mortgage. At 4-6% it's a transitioning gray area with increasing number of incentivized scenarios for paying down my mortgage. At 6+%, there start to be significant incentive to pay down my mortgage. 

Duke said:

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

Just like the other examples, it's simply the total value of your assets at the end of the 30 year period. So it's automatically baked in.

In reply to STM317 :

I think the annual average rate of investment return is higher than the 7% you cited.

Perhaps that number is inflation adjusted or assumes a portfolio that includes bonds or picks a time period that was below the 50th percentile of returns.

In my mind, 10.8% on the S&P 500 minus 3.0% for inflation = 7.8% which using the Rule of 72 tells us that after adjusting for inflation, your money will double in value about every ten years.

ProDarwin said:

bobzilla said:

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?

Agreed those are not emotional things.  But the emotional response to being debt free is what allows for that.

The saving scenario also allows for all of that, but it doesn't come with the warm fuzzy you seek.

to her the combo of both does. Me? I make poor financial choices. I like nice vacations, race cars and guns. She makes calculated smart decisions that allows me to have the other things. 

It's always a balance: present vs future vs far-future.   And everyone's situation tends to be a different.  Sometimes peace of mind in the near future is worth more than a few extra $ in an account you might not live long enough to see. 

trucke said:

In reply to STM317 :

You are correct!  We are discussing only a mortgage debt.

Unfortunately, many people have school loans, car loans, credit card, medical payments, mortgage.  When you look at a debt-free strategy in those scenarios, the numbers will show debt-elimination as the clear winner.

Yeah, but those are a different type of debt than a low interest mortgage with tax advantages for an asset that typically appreciates.

Ultimately, the only math calculation that needs to be done is determining how the expected rate of return of an investment compares to the interest of the debt. Then, based on that spread you can assess whether the guaranteed return of debt paydown is justified over the risk of higher returns from investing that money based on the individual's risk tolerance.

Ian F (Forum Supporter) said:

It's always a balance: present vs future vs far-future.   And everyone's situation tends to be a different.  Sometimes peace of mind in the near future is worth more than a few extra $ in an account you might not live long enough to see. 

wife and I both know people that scrimped and saved for the future and forgot to have fun along the way. None of the got to enjoy it.

The penalties in this case make this a poor idea.  
 

That said the discussion here about paying a mortgage early or not is interesting,  most people focus on interest rates and say well it's only 4% and you can earn 7% or better.  This sounds like a financial advisor and those people aren't looking at things in total..  What you need to worry about is INTEREST in dollars and not based on rates.  
 

You owe $70k on the house at 4%.  Simple interest  alone says that's $2800 a year given to the bank for nothing.  For someone living in a bigger, new house with no down payment it is far worse.  You can earn 7% on your 17k.  That's $1190.  You are still falling behind each year.  That's the rat race and I want to teach my kids to avoid it completely.  
 

If you have a 300k mortgage at 5% and a credit card balance of $2000 at 20% every financial planner on the planet will tell you the credit card is hurting you more than the mortgage.  They only look at rate and not the actual interest.  Interest is just dollars you are giving away.  If you think I hate interest, don't ask me about fees or tipping at the self checkout.

Always remember if you have $0.10 there is someone on this planet willing to rob you or worse to get it.  

In reply to AnthonyGS (Forum Supporter) :

If you put say $200 a month toward a loan that has interest, you will get the maximum benefit by paying toward whatever has the highest interest rate, regardless of balance or total monthly interest charge in dollars.

In reply to AnthonyGS (Forum Supporter) :

The other point- when you shop for mortgages, find ones that don't have penalties for ending early.  Or constantly refinancing to chase lower rates and better terms.

And why did this thread come back after a long delay?  A mortgage for a canoe?

Inflation is killing any market gains.  If the market is going down or stagnant and inflation is high investing isn't making real gains even if the numbers go up.  If your dollars buy 7% less due to inflation your 7% return gets wiped out but the financial companies always get their fees.  The market is stagnant at best.  And you pay interest based on $$$$ not rate.  The same goes for investments.  You want $$$$.  Making 100% on a $500 trade is nice but it's not life changing. 

AnthonyGS (Forum Supporter) said:

Inflation is killing any market gains.  If the market is going down or stagnant and inflation is high investing isn't making real gains even if the numbers go up.  If your dollars buy 7% less due to inflation your 7% return gets wiped out but the financial companies always get their fees.  The market is stagnant at best.  And you pay interest based on $$$$ not rate.  The same goes for investments.  You want $$$$.  Making 100% on a $500 trade is nice but it's not life changing. 

You’re wrong on both of these points. 

1. As others have said, you always pay down the highest interest rate debt first. The total balance does not matter. The total interest on the loan does not matter. Example: You have a $10,000 debt at 10% interest and a $300,000 debt at 3% interest. Every year you’ll owe $10,000 in interest payments (10,000*.01+300,000*.03). $1,000 is from the 10% loan and $9,000 is from the 3% loan. If you pay off $1,000 of the 10% loan, your annual interest accrual goes down by $100. If you pay off $1,000 of the 3% you only save $30. Always pay the highest interest rate loan first.

2. The stock market is up about 14% year to date, about 16% over the last 12 months, and about 53% over the last 5 years. These are numbers from the commonly purchased “VTI” total stock market index fund, and does not include dividends paid by the fund (about 1.5% annually, so actual net returns are higher than what I quoted). This return is well above inflation over the same periods (2%, 4%, and 21% respectively according to the BLS calculator). If you have money to invest just stick it in an index fund and let it grow.