Do you have money saved up for retirement? Have you ever thought about taking those funds out and using them to pay down the mortgage? You think it’s a good idea because you’re getting rid of your debt, but is it a wise move when you look at the long term results?
I have heard this question quite a lot lately – “I have some pretty good money saved up for my retirement, but we still owe on our house and will have to continue making payments for another 10 years. Would it be a good idea for me to take the money out and pay off my mortgage?”
This question keeps coming up because people are beginning to realize how stupid debt really is. It’s borrowed money that often costs twice the amount to pay back. Plus, in the event of an emergency, it’s possible that the loan payments can’t be made. All of the sudden you might be saying, “Bye-bye house” as the bank takes back what’s rightfully theirs. If you owned your house in full, there would be no need to worry.
What Is the Downside of Pulling Money Out of Your Investments?
There are downsides to nearly every decision, and this one has a few:
- Penalties – If you’ll be removing your money from a retirement account (like a 401(k) or a Roth IRA) and you are not of a certain age (typically 59 1/2 years old), you will be penalized for your withdrawal (normally, this is 10%).
- Capital Gains – Yes, you’ll have to pay them sooner or later, but just be aware that once you remove your money from your investment accounts, your earnings are realized and you’ll have to pay taxes on those gains.
- Lack of Retirement Funds – What if you pulled every last penny out of your retirement funds to pay off your house? You now have absolutely no liquid cash for retirement – it’s all stuck in your house. When you near your retirement years, liquidity is very important, so be cautious before making any hasty decisions.
What are the Benefits to Paying Off Your House?
The benefits are actually very simple:
- Save Money on Interest – By paying down your house early, you’ll save yourself a boat-load of money because you didn’t have to make those monthly interest payments on the remainder of the loan!
- Live in Peace – When money is tight and you’re not sure you can make the mortgage payment from month to month, that’s pretty stressful. Miss enough payments and you’ll be on the street. If you could just own the house in full, life would be so much more peaceful.
What Would I Do?
So if I had the choice, what would I do in this situation? You all know how much I hate debt, and you might think that I’ll tell you to do whatever’s necessary to pay it off, but I’m not heading down that road this time. As you can see from the variables listed above, there are many factors that play into this decision and every situation is a little different, so there is absolutely no correct standard answer here. Mainly, my answer depends on the potential penalty for removing the funds.
The 10% Penalty for Early Withdrawal
If my money was coming from a 401(k), 403(b), or a Roth IRA, I would absolutely leave the money in the account. There’s just no sense in taking a 10% penalty to pay for a 4% interest loan.
No Penalty on the Withdrawal
If there was no penalty on the withdrawal from my investment account, I’d most certainly use it to pay off the debt, but I would make sure to have enough money for taxes.
Let’s say you put $50,000 into your investment account over the years, and now it’s worth $80,000; the government will expect to see some tax money on that $30,000 gain. At the very minimum, I would set aside $10,000 (or approximately 1/3 of the capital gains) for Uncle Sam, but I would use the rest of the money and put it toward the mortgage.
What would you do? Would you pull out the money to pay off your house?
I think about this a lot. The problem is I no longer live in the house and my wife and I have decided that we never will. So right now we are just keeping it afloat. However if it were paid off we could have a nice income. For me I say no we don’t pay it off and we just keep it until the economy rebounds in 4000 years and then try to have our great great great great…. grand kids sell it.
It seems like the housing market is starting to bounce back (at least in my area), but with the interest that you’re being charged, I would consider paying extra.
I’ve thought about this. Right now I don’t have enough in retirement to do this though.
Michelle recently posted..Spending, Life, Income and Food Updates… 2/20/2012
Yeah, I definitely wouldn’t advise draining your retirement accounts down to zero. You may retire, and have a paid-for house eventually, but you’ll have no cashflow.
I would not sacrifice retirement funds to pay off the house unless I had an incredible surplus. Use the earnings off the retirement principal to make the mortgage payments instead.
cashflowmantra recently posted..Options Expire Today (Actually Tomorrow)
Let’s say you’ve got a $200,000 house that you’re paying 4% interest on for 30 years. If you don’t pay any extra, then you’ll end up paying $400,000 on that house. With the market the way it is, I think it might be a stretch to turn $200,000 into $400,000. Paying off the house is a guaranteed win.
I would rather invest it first to business. Once i pay off the house but no other income. It is hard to look for another income job.
Oooo, unless it’s a low-cost start-up, that sounds crazy risky. You’ll have a house mortgage and a business loan? I’d go for the sure-fire interest savings by paying off the house, then I could start a new venture.
Retirement funds are a last resort. I would only touch them to avoid some major financial catastrophe like bankruptcy. I’ve had friends ask me a similar question but they were wanting to pay off student loans and credit card debt, ugh no way.
There is one caveat regarding the Roth IRA. After 5 years you are able to withdraw the principal penalty free, so if it was absolutely necessary I would start there but only as a last resort.
How much have investment accounts made over the past 10 years? I’m pretty sure it’s at about 0%… Paying off the house would have saved thousands of dollars (sometimes even 6 figures). That’s why I’m shooting to pay off the house.
I hear ya. While I’m not withdrawing any funds from my retirement accounts I am not contributing any longer until my house is paid for (except for the 401k’s, I can’t ignore that match).
Since we are halting our contributions for 2 years while we pay the house off we put a priority on back-filling them as soon as it is paid off.
Very nice Matt. Pay that house off as fast as possible, and then you can really invest for the future after that! Don’t worry about investing in the 401(k)s, both my wife and I contribute to ours too. That match is a great benefit. I had some other stocks that I owned a couple of years ago – I sold those to pay off my debts. It was a great decision and I’ll never regret it.
I wouldn’t sacrifice retirement funds just to pay off my mortgage early. My question would be are you investing too much for your retirement? Do you need to back off some from the amount that you are investing (not money already invested) and shift more of your excess money towards your mortgage? That may be a better solution than withdrawing funds, paying penalties, etc.
Hank recently posted..Counting The Cost Of Uninsured Drivers
Are your investments making 4%+ each year? Some of mine are, but certainly not all of them Why wouldn’t you go for the sure win? About the penalties though – I said I wouldn’t take them out if that were the case. Paying penalties doesn’t make any sense.
I think the paid off home is important, however the money is sunk. It is difficult to cash out easily and can be expensive to do so. Sale includes a commission or a reverse mortgage is not cheap either. Home values are not what they used to be. Paying off your mortgage is more psychological than anything else.
krantcents recently posted..The 3 F’s of Success
Paying off the home is psychological, but it also reduces the money that you would have lost in interest! By paying our house off early, we’re going to save $20,000!
With interest rates so low, I would advise that a winning strategy for many would be to re-finance to a term that will let you pay off before you’re set to retire. Going into retirement with a mortgage is a definite no-no in my book, but with rates so low, I see little issue with paying an affordable mortgage payment as well as saving in the 401(k) for working people.
Money Beagle recently posted..Don’t Get Tunnel Vision When It Comes To Your Finances
Absolutely not. Retirement money is for retirement!
Jackie recently posted..The One Thing You Need to Start a Small Business
I guess we find something that we disagree on Jackie. There are some retirement accounts that are making basically nothing lately, but yet, their house is costing them $500 in interest each month! Why not stop the pain and pay off that house?
Great topic Derek! Most people don’t actually spend 30 years in the same house. Therefore, very rarely does one make that final 360th scheduled payment on their mortgage. I am working on buidling a huge surplus of liquidity. If I ever get a firm desire to pay my low interest mortgage off, I’ll use these funds. I’d be willing to bet that we’ll all see 8% CD rates again.
BE @ BusyExecutiveMoneyBlog.com recently posted..3 Easy Steps to Living Below Your Means
The only problem is, once the CDs become 8% again, the inflation rate will probably be at 15%….
That’s a tough one. If your investments are making more interest than your mortgage is charging, then rationally.. I’d leave it invested. If you’re not comfortable carrying the weight of a mortgage, it might be better to aggressively pay it off (simply for peace of mind). There’s also the issue of accessing the money if need be in an emergency… and if it’s tied up in your house, that poses a difficult challenge.
Julie @ Freedom 48 recently posted..When Financial News Becomes a Financial Embarrassment
Well put Julie. A retirement fund should not be used as an emergency fund, so there should be other money set aside in the event of an emergency.
Great article Derek. It’s certainly an interesting question you pose and I can see both sides of the discussion. I suppose if there’s no penalty to withdrawing from the account, it might be considered acceptable as a last resort.
Thanks,
Timothy
Wealth Artisan recently posted..50 Cent Stamps: U.S. Postal Service Plans Price Increase
A 4% guarantee or a historical average that has proven itself to be false in the last 10 years? I’s take the guaranteed 4% every time.
Greetings Derek!
I can’t say I’d recommend using your retirement funds to pay off your house, but then again, if you can save a significant amount of money on interest, then it might be worth it.
Humbly Yours,
The Mayor
Mayor of Humbleville recently posted..Recipes to Use Leftover Blueberries
It sure would be worth it! If I can save $100,000 by paying my house off early, why wouldn’t I do it??
I see this question pop up a lot. As long as you’re not tapping your 401k, I say go for it. The last thing that you want to do is have $80,000 in your account and two years down the road, you’re looking at $60,000 because of losses. It’s better to play with investments when you have no debts at all!
I agree with you 100% Hannah. Finally! Somebody that sees it my way!
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I cannot think of a worse financial decision than using retirement money to pay off a a home loan regardless of the reason.