Stop 401(k) contributions to pay off the mortgage?

[dollface219]

Okay, here's the scenario. I purchased my home as a foreclosure 2 years ago, and have enough equity to refinance at a lower APR and get rid of the private mortgage insurance that I have to pay each month ($39). I have finished college, so I am looking at paying off my student loans (approxmiately $30,000) with the equity in the home.

If I refinance the house for 15 years, I will have a 4.25% APR and my student loans and my mortgage will be paid off by 2026! The only thing is, this (obviously) makes extra spending money tight every month (provided I make the same money for the rest of my life and I hope that I don't!)--but the overall goal is highly appealing. To counter this, I was considering stopping my 401(k) contributions. I know! Everything I read online says "bad move!" BUT, I'm only 23 years old. By the time the mortgage/student loans are paid off, I will be 38 years old. At 38 years old, I'll have about $1100 per month "free" because the new mortgage will be paid off! Even if I put half of that into a retirement fund at that point in my life, I would have financially benefitted by saving interest and having a paid-in-full house. However, my employer does match 50-cents to the dollar (up to 4%) of 401(k) contributions (so it's really a total of 12% of my income that I'm shoving into retirement funds). And I also want to consider how much money I would be "missing out on" if I were to stop contributions (I currently save $169/mo and the company contributes about $85/mo, so a total of $254 each month is put into retirement). Again... I'm only 23! But I do acknowledge that the more I start saving now, the less I have to worry about in the future.

I've also thought about refinancing anyway for the outstanding loan amount of the house to 15 years and keep the student loans as a separate payment (15 year term as well). However, combining the two saves me about $8,000 over the course of the 15 years and the payment would be lower than if the two were separate.

Anyone else like my idea? Or can see any drawbacks that I can't?

[disneysteve]

If I refinance the house for 15 years, I will have a 4.25% APR

To counter this, I was considering stopping my 401(k) contributions.

my employer does match 50-cents to the dollar

So you want to pass up a guaranteed 50% return on your money in order to "save" 4.25% on your mortgage (really less than that due to the tax deduction. And you want to delay starting your retirement savings until you are 38.

That makes absolutely no sense whatsoever. I think I've made it clear why it is a really, really bad idea.

[jIM_Ohio]

Okay, here's the scenario. I purchased my home as a foreclosure 2 years ago, and have enough equity to refinance at a lower APR and get rid of the private mortgage insurance that I have to pay each month ($39). I have finished college, so I am looking at paying off my student loans (approxmiately $30,000) with the equity in the home.

If I refinance the house for 15 years, I will have a 4.25% APR and my student loans and my mortgage will be paid off by 2026! The only thing is, this (obviously) makes extra spending money tight every month (provided I make the same money for the rest of my life and I hope that I don't!)--but the overall goal is highly appealing. To counter this, I was considering stopping my 401(k) contributions. I know! Everything I read online says "bad move!" BUT, I'm only 23 years old. By the time the mortgage/student loans are paid off, I will be 38 years old. At 38 years old, I'll have about $1100 per month "free" because the new mortgage will be paid off! Even if I put half of that into a retirement fund at that point in my life, I would have financially benefitted by saving interest and having a paid-in-full house. However, my employer does match 50-cents to the dollar (up to 4%) of 401(k) contributions (so it's really a total of 12% of my income that I'm shoving into retirement funds). And I also want to consider how much money I would be "missing out on" if I were to stop contributions (I currently save $169/mo and the company contributes about $85/mo, so a total of $254 each month is put into retirement). Again... I'm only 23! But I do acknowledge that the more I start saving now, the less I have to worry about in the future.

I've also thought about refinancing anyway for the outstanding loan amount of the house to 15 years and keep the student loans as a separate payment (15 year term as well). However, combining the two saves me about $8,000 over the course of the 15 years and the payment would be lower than if the two were separate.

Anyone else like my idea? Or can see any drawbacks that I can't?

YES, the biggest drawback is retirement will cost you more.

For example if you invest $1000/mo from ages 23 to 33, then nothing after, and then from age 34-54 just let money grow, get an 8% return along the way you would have $875k in 30 years.

If you skip investing $1000/mo for 10 years, then invest $1000/mo for 20 years. get same 8% return, you have just short of $600k in 30 years.

In first example you invested $120k and have $875k, that is a 700% return.
In second example, you invested $240k and have $600k, which is about a 250% return.

In the second example, even if you doubled the 1k/mo to 2k/mo, you still have the same 250% return (lower return)... you do have "more money" but you also had to invest 4X as much to get more money.

Don't skip investing early because of cash flow. Analyze problem deeper and you will find another good solution. You are thinking about money, which is a good thing, but I don't think you analyzed problem fully or correctly.

1) Baseline-
what are the terms of current mortgage?
what are the terms of current student loans?
how much are you current investing? Gross amount and as a % of gross income.

2) Baseline- on a timeline
After assessing the current terms, put the payoff of both on a timeline.
The student loans usually have a 10 year payoff (unless you have consolidated and changed terms) and a mortgage is usually a 15 year or 30 year payoff. If you planned to put the student loan payment to the mortgage in year 11 once paid off, make that baseline 1a because you need that for comparison purposes for other analysis.
How aggressively do you invest? What return do you shoot for (7-8-9%)?

3) Refinance-
If you refinance and just take a lower mortgage payment, how do the above timelines change?

3a) refinance 2- if you take the savings from the refinance and snow ball the student loan debt, how much does the timeline change?

3b) refinance 3- if you take the savings from the refinance and invest it, how do the above timelines change?

3c) refinance 4- if you take the savings from the refinance and immediately pay down mortgage more, how do above timelines change?


More than likely 3a or 3b is better than rolling the student loans into the mortgage. Here are factors to consider

a) how much interest do you pay on student loans until they are paid off?
b) Is there a tax deduction on current student loans?
c) If the student loans were refinanced with mortgage, what is the interest paid in that situation on just the student loan debt? Meaning you need the baseline to know normal mortgage interest paid, then compare that number with interest paid if student loan debt is included- the number I am looking for is the difference.
d) Is there a tax deduction on the mortgage interest, and if so, how much of that is from the student loans?

The issue is if the student loans are being repaid in 10 years at 6% you might be paying $1000/year in interest and might pay $5000 over next 10 years to pay the loans off.
If you add this into a 15 or 30 year mortage, the probability is you will pay more in interest because of the length of time and sum of money borrowed, so even if that 6% drops to 4.25%, because you added 5 or 20 years of payments, you pay more in interest.

Your best "bet" is do this, if you are wanting to consolidate debt or eliminate payments:

1) if goal is be debt free, invest about 10% of gross pay into retirement accounts, then pay extra on highest interest debt. Once one debt is paid off, focus on next highest interest rate.

2) If goal is to remove payments from monthly budget, invest about 10% of gross pay into retirement accounts, then focus on the timeline and pay extra to loan which is easiest to pay off early (might be lowest principal, might be highest monthly payment, might be something else depending on loan specifics).

3) If goal is highest net worth in X years, you want to invest more than 10%.

[sandrark]

I'm with DS on this. Bad idea, bad idea, bad idea.

What if you get laid off? What if you end up in an auto accident? Or, my personal favorite with a friend dying - how about if you get cancer?

My biggest financial strength has been all about not having ALL my financial eggs in one basket. Your plan is exactly that.

What I did is to print out an amortization chart for my mortgage, and decide when we wanted the house paid off. This HAD to be done in concert with putting away 20% of our GROSS INCOME into retirement, as DH bought his own business in 2001, and is behind in his retirement savings.

What I discovered was that we could pay an extra $200 per month on the mortgage, and reduce our 15 year loan into 12 years. If we paid $400 per month, it was 10.5 years.

We decided we'd stick with $200 per month, and at the end of the year, we'd write a check to round it up to the nearest $1000 in principle repayment.

This strategy gets us a lot of benefits -

1) Aggressive savings for retirement, which compounds over 25 years.
2) Aggressive and REGULAR prepayment of the mortgage.
3) Cash flow considerations are good - we can sustain this plan without huge sacrifice.
4) We won't have a paid-off house and no income when we're retired. THIS IS YOUR PLAN'S BIGGEST RISK.

If I were in your shoes, I'd be focusing on saving all of that pre-payment money in your retirement account, AFTER you refinance into a 15 year, fixed-rate mortgage. This will really limit the tons o' cash going to interest payments, which means more cash in your pocket in the long run.

Good luck!

Sandi

[MonkeyMama]

I think it's hard for young people to understand inflation, opportunity cost, and the kinds of risk that come with this strategy. ("Being mortgage-free is risk-free," is simplistic thinking. In most cases, retirement funds are the most safe from creditors, lawsuits, etc., etc. Also, until the mortgage is fully paid, a few missed payments can spell disaster. In theory, it could be much more cautious to take a longer loan. With age you will see more around you face prolonged job loss, disability, etc., etc. which are all likely risks that most people face).

You certainly don't want all your eggs in one basket.

Anyway, any financial expert will tell you that you will come out ahead by saving for your retirement over pre-paying mortgage.

I know many are skeptical of the numbers, but most of our older family members never made pre-payments to their mortgage, nor took on 15-year mortgages (before they were older and it was a smaller percentage of income anyway), and most of them paid off their mortgages in 20 years without really trying that hard. I mean, these are not people who bought up every decade or ever borrowed against their home. But they focused on investing/retirement/saving first, and then over time as their income increased, they found they had the means to pay off their mortgage early.

I'm 33. I had a 15-year mortgage when I was 23. We refied to a 30-year when we had kids and dropped to one income. With age and wisdom I much prefer the 30-year mortgage, though we may pay it off in 15 years time. I prefer the lower fixed payment in case of emergency though. I didn't really *get* that in my young 20s.

[jpg7n16]

...Or can see any drawbacks that I can't?

1) You say you're only 23... so let's play that out. I'll imagine you want to retire at 65. If you put your plan into action, you will have no debt and no savings in 15 years - when you will be 38. That leaves you with only 27 years left to save for retirement.

By passing up these 1st 15 years, you are passing up over 1/3rd of the time you have to save for retirement.

2) By deferring compensation to your 401k, you are deferring taxes each year. If you stop the 401k you increase your taxes.

3) See Steve's post above. - passing up 50% for free to save 4.25% = bad idea.

4) Interest on student loans is guaranteed to be deductible (if your income is within the limits) - while home interest is deductible only if the interest (and other itemized deductions) is more than the standard deduction.


A financially healthy person should be able to save for retirement, fulfill reasonable debt obligations, and still not be strapped for cash each month.

If the cost of this home is causing you to be strapped for cash, then you have too much house. If you have great equity, have you considered selling the home? (then buy a cheaper home and apply the extra equity to the student loans to knock them out - or as a larger down payment on the new home) These strategies would a) lower your outstanding debt; b) free up tons of cash each month; c) allow you to save even more towards retirement

If you choose to sell the home, wait until you're sure you've owned it for over 2 years and you can sell it and pay no tax on any gain (sales price minus purchase price) of up to $250,000.


Oh and ps - you can refinance the home without rolling the student debt into it. If it saves you a good bit on the interest rate, it could easily still be worth your time to refi.

[jaine]

I agree with the others especially if there's an employer match involved. You'll be thanking yourself in 10 years if you keep contributing to the 401k - enough to get the full employer match at a bare minimum.

[jIM_Ohio]

I think it's hard for young people to understand inflation, opportunity cost, and the kinds of risk that come with this strategy. ("Being mortgage-free is risk-free," is simplistic thinking. In most cases, retirement funds are the most safe from creditors, lawsuits, etc., etc. Also, until the mortgage is fully paid, a few missed payments can spell disaster. In theory, it could be much more cautious to take a longer loan. With age you will see more around you face prolonged job loss, disability, etc., etc. which are all likely risks that most people face).

You certainly don't want all your eggs in one basket.

Anyway, any financial expert will tell you that you will come out ahead by saving for your retirement over pre-paying mortgage.

I know many are skeptical of the numbers, but most of our older family members never made pre-payments to their mortgage, nor took on 15-year mortgages (before they were older and it was a smaller percentage of income anyway), and most of them paid off their mortgages in 20 years without really trying that hard. I mean, these are not people who bought up every decade or ever borrowed against their home. But they focused on investing/retirement/saving first, and then over time as their income increased, they found they had the means to pay off their mortgage early.

I'm 33. I had a 15-year mortgage when I was 23. We refied to a 30-year when we had kids and dropped to one income. With age and wisdom I much prefer the 30-year mortgage, though we may pay it off in 15 years time. I prefer the lower fixed payment in case of emergency though. I didn't really *get* that in my young 20s.

1) You say you're only 23... so let's play that out. I'll imagine you want to retire at 65. If you put your plan into action, you will have no debt and no savings in 15 years - when you will be 38. That leaves you with only 27 years left to save for retirement.

By passing up these 1st 15 years, you are passing up over 1/3rd of the time you have to save for retirement.

2) By deferring compensation to your 401k, you are deferring taxes each year. If you stop the 401k you increase your taxes.

3) See Steve's post above. - passing up 50% for free to save 4.25% = bad idea.

4) Interest on student loans is guaranteed to be deductible (if your income is within the limits) - while home interest is deductible only if the interest (and other itemized deductions) is more than the standard deduction.


A financially healthy person should be able to save for retirement, fulfill reasonable debt obligations, and still not be strapped for cash each month.

If the cost of this home is causing you to be strapped for cash, then you have too much house. If you have great equity, have you considered selling the home? (then buy a cheaper home and apply the extra equity to the student loans to knock them out - or as a larger down payment on the new home) These strategies would a) lower your outstanding debt; b) free up tons of cash each month; c) allow you to save even more towards retirement

If you choose to sell the home, wait until you're sure you've owned it for over 2 years and you can sell it and pay no tax on any gain (sales price minus purchase price) of up to $250,000.


Oh and ps - you can refinance the home without rolling the student debt into it. If it saves you a good bit on the interest rate, it could easily still be worth your time to refi.

Two good posts above

Its important to recognize when to "sell out" and use money for one purpose and only one purpose... this is probably not the time to do that. Its OK to pre-pay mortgage, but not at expense of other goals (like retirement), or pre-pay student loan debt, but again don't prepay at the expense of another goal (like retirement).

Retirement may seem really far away, I will add 3 thoughts

1) You will either retire or work until the day you die, the choice is yours.
2) When funding financial goals, always fund the longest term goal first
3) When it comes to finances, few answers are black and white, just many shades of gray. There are certain key elements (like spend less than you earn), but after that things get gray fast.

[maat55]

Do not give up matching dollars or investment dollars for equity. Equity does not earn interest.