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I'm not too excited about the stock market right now. What do you guys think about borrowing from my 401K to pay down my mortgage?

Current mortgage is ~$194K @ 5.25%. I can get a 10-year loan of $20K on my 401K at 4.77% and apply it to the principal.

It's an investment property. i know if I lose my job, then I need to pay the balance immediately. I have the cash to do that, if necessary.

i've been paying extra down on the mortgage because I think the 5.25% is better than I'll make in the market.

What am i missing other than potential appreciation in the market? Don't i pay the interest to myself, so in effect this is a 0% second mortgage of $20K?

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Whatever the 401k is invested in and whatever it earns as a result is taxed as income upon withdrawal. We all agree on t... (more)

fw101 (Feb. 11, 2013 @ 10:24a) |

Because you are not borrowing your own money with a bank loan. Maybe you look at it differently, but I consider a 401k l... (more)

unnamedone (Feb. 11, 2013 @ 7:28p) |

You can consider it and describe the loan anyway you like.
Is your tax obligation any different in the two situations. I... (more)

fw101 (Feb. 11, 2013 @ 11:29p) |

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Don't do it.

habback said:   I'm not too excited about the stock market right now. What do you guys think about borrowing from my 401K to pay down my mortgage?

Current mortgage is ~$194K @ 5.25%. I can get a 10-year loan of $20K on my 401K at 4.77% and apply it to the principal.

It's an investment property. i know if I lose my job, then I need to pay the balance immediately. I have the cash to do that, if necessary.

i've been paying extra down on the mortgage because I think the 5.25% is better than I'll make in the market.

What am i missing other than potential appreciation in the market? Don't i pay the interest to myself, so in effect this is a 0% second mortgage of $20K?

401k is meant for retirement. How old are you? Invest for a time horizon commensurate with it. Over the long run, you will do better.

kilacam19 said:   Don't do it.
I second that. First off, you should be able to get a better return than 5.25 annually on your retirement unless you are investing very, very conservatively. Second, you will be losing out on the growth of all of the money you take out of your retirement from the 10-year payback. Third, who says your home will actually appreciate and if the worst happens and catastrophe strikes you financially, your retirement funds are protected in bankruptcy. I could go on and on. Don't borrow or cash out retirement funds...you are investing in your future for retirement for a reason.

IF you have the cash, pay the mortgage with that.

An investment property mortgage at 5.25%? If you have a good credit profile, LTV < 75% and good DTI I don't see why you are not getting around 3% for a 10 year mortgage with a normal rate and term refinance. Provident Funding is offering that with about < 1 point so you should be able to get close to 3% anywhere. Have you considered just getting a refinance? You would lower your payments substantially.

boxerbrief said:   An investment property mortgage at 5.25%? If you have a good credit profile, LTV < 75% and good DTI I don't see why you are not getting around 3% for a 10 year mortgage with a normal rate and term refinance. Provident Funding is offering that with about < 1 point so you should be able to get close to 3% anywhere. Have you considered just getting a refinance? You would lower your payments substantially.

I've tried everything, but the building is majority investor-owned (condo in downtown DC). LTV is at 75%. Willing to bring cash as well, but no one will touch it. Anyone have any ideas?

Appreciate the comments - trying to be creative and squeeze out what I can.

uutxs said:   habback said:   I'm not too excited about the stock market right now. What do you guys think about borrowing from my 401K to pay down my mortgage?

Current mortgage is ~$194K @ 5.25%. I can get a 10-year loan of $20K on my 401K at 4.77% and apply it to the principal.

It's an investment property. i know if I lose my job, then I need to pay the balance immediately. I have the cash to do that, if necessary.

i've been paying extra down on the mortgage because I think the 5.25% is better than I'll make in the market.

What am i missing other than potential appreciation in the market? Don't i pay the interest to myself, so in effect this is a 0% second mortgage of $20K?

401k is meant for retirement. How old are you? Invest for a time horizon commensurate with it. Over the long run, you will do better.


I'm 26

If you've got the cash, pay with that and if necessary stop contributing until your reserves are rebuilt. Try to find a broker that specializes in those loans, and maybe hold off on paying down until closing the new loan.

psychoslowmatic said:   If you've got the cash, pay with that and if necessary stop contributing until your reserves are rebuilt. Try to find a broker that specializes in those loans, and maybe hold off on paying down until closing the new loan.

As a non-warrantable investment property, I dont think he will probably do much better than 5.25%. Thats just the reality of the situation. I was gonna suggest that most home equity loans dont check if a condo is warrantable but the rates are far from 5.25...

habback said:   I'm not too excited about the stock market right now. What do you guys think about borrowing from my 401K to pay down my mortgage?

Current mortgage is ~$194K @ 5.25%. I can get a 10-year loan of $20K on my 401K at 4.77% and apply it to the principal.

It's an investment property. i know if I lose my job, then I need to pay the balance immediately. I have the cash to do that, if necessary.

i've been paying extra down on the mortgage because I think the 5.25% is better than I'll make in the market.

What am i missing other than potential appreciation in the market? Don't i pay the interest to myself, so in effect this is a 0% second mortgage of $20K?

This is actually a decent idea, and the reason you're getting negative comments is because (IMO):

1. Most people waste the money when they take a 401k loan, and it ends up as a penalized withdrawal
2. They disagree with your conservative view on the market

IF you're responsible about using 401k loans, they can be great. You can use them to avoid crappy 401k investment options and take the cash to invest in similar funds elsewhere, etc, but that responsibility is a big "if". Almost no one is responsible with these loans, but you're on FWF some I'm giving you the benefit of the doubt here.

Why does this make sense for OP? If you hold bonds only in your 401k, consistent with a pessimistic market view, clearly your 401k is better off since its getting a risk free 4.77% instead of 2% for a similar treasury bond (you won't default on yourself, right?). In some sense this is a way to make an addition 401k contribution (in the amount of the excess interest less loan fees), which should be good for a young saver. Now on the taxable side, he's needs to provide us with tax info to figure the true mortgage cost - that 5.25% is only around 4% if he's in the 25% bracket and itemizes deductions, and could be in the mid 3%'s depending. Note 401k loan interest is not deductible. All that said, it seems likely that:

1. OP might be strictly better off with the loan (if the tax effective rate on the mortgage is higher than 4.77%),
2. He will probably be better off in aggregate (him + 401k together), which is good enough if he's willing to subsidize his 401k some, and

3. He should also pay most of his surplus cash towards the mortgage consistent with his market views.

Smiley1 said:   First off, you should be able to get a better return than 5.25 annually on your retirement unless you are investing very, very conservatively. Second, you will be losing out on the growth of all of the money you take out of your retirement from the 10-year payback. Third, who says your home will actually appreciate and if the worst happens and catastrophe strikes you financially, your retirement funds are protected in bankruptcy. I could go on and on. Don't borrow or cash out retirement funds...you are investing in your future for retirement for a reason.
1. You might expect to get more than 5.25% by investing, but there's lots of risk with holding 75-100% equities or similar investments that have realistic prospects of hitting those return targets, given the fixed income allocation is earning basically nothing, the market valuations are up a fair bit, and the equity risk premium should be based off current risk free rates rather than estimating stocks future prospects from their past raw returns (as an example of the latter, stocks should expect to return 5% less at constant PE when risk free is 0% than they did when risk free was 5%). Also remember that your suggestion is equivalent to telling OP to buy stocks on margin at a 5.25% rate, which means there's a real risk of underperforming 5.25% on his investments and losing real money that wouldn't have been lost otherwise like if he just paid down his mortgage. Stocks have lost nearly half their value twice in the last decade or so, just as a reminder.

2. The growth on the 401k will be higher than any conservative fixed income option, as I described in my post above.

3. He's losing the "walk away from his mortgage" option, but his 401k funds are still protected from creditors. The amount borrowed might not be, although stashing it in his house as he plans to will often have similar "homestėad" protections (check your state, FL is especially good). Even so, in many financial misfortunes, he could repay the loan from his CCs or cash to avoid this. Remember we're not talking huge money - 401k loans are capped at the smaller of $50k/50% of the balaance and a conservative and young OP probably isn't hitting the high end of that.

habback said:   I'm not too excited about the stock market right now.

Not really an answer to your question, but...

Shouldn't people, especially at 26, be buying when things are not exciting, and selling when things are?

Also, watch out the the tax penalty.

Mulligan said:   habback said:   I'm not too excited about the stock market right now.

Not really an answer to your question, but...

Shouldn't people, especially at 26, be buying when things are not exciting, and selling when things are?


I'll for one say, I'm pretty freaking excited about the market right now. I don't get these people that are all doomsday, end of the world, market will crash everyday thing. Sure, it could happen, maybe it will. That'll be a great time to plow cash in though. For what it's worth, both the DOW and S&P have gone up more than ~5.25% since the beginning of the year...so, what more do you want to be excited about? At 26, you should leave your retirement investments alone. The lost opportunity cost for a 10 year loan is huge, then add in the interest, and associated risk...

If your investment property if cash flow positive, neutral, or even slightly negative, you're probably fine. For it to make sense, you'd have to assume that the property will appreciate in those 10 years roughly equivalent to your earnings on the loan amount you take out. I wouldn't take that bet.

I took a loan out of my 401k in the spring of 2008 - The max amount I could - not because I predicted the stock market plummeting but because I was young (23) and stupid and needed it to do the things single 23/24 year old males do... Needless to say, it would have turned out to be a great move, if I had used that money responsibly...

Not a dumb question at all. With me, I only owe about $36,000 on my mortgage with a monthly payment of about $700. I have a Roth IRA and 401(k). I figure I can easily take out $36,000 out of my Roth IRA with no penalty since I have more than that in my own contributions and just pay off the mortgage. I reduce my monthly expenses by $700. The chances of me making $700 a month on my $36,000 consistently in my Roth are less than winning the lottery. I'm seriously considering doing this.

burgerwars said:   Not a dumb question at all. With me, I only owe about $36,000 on my mortgage with a monthly payment of about $700. I have a Roth IRA and 401(k). I figure I can easily take out $36,000 out of my Roth IRA with no penalty since I have more than that in my own contributions and just pay off the mortgage. I reduce my monthly expenses by $700. The chances of me making $700 a month on my $36,000 consistently in my Roth are less than winning the lottery. I'm seriously considering doing this.

You're ignoring lost opportunity cost in the IRA.

burgerwars said:   Not a dumb question at all. With me, I only owe about $36,000 on my mortgage with a monthly payment of about $700. I have a Roth IRA and 401(k). I figure I can easily take out $36,000 out of my Roth IRA with no penalty since I have more than that in my own contributions and just pay off the mortgage. I reduce my monthly expenses by $700. The chances of me making $700 a month on my $36,000 consistently in my Roth are less than winning the lottery. I'm seriously considering doing this.

Difference here is, you can NEVER recover that tax-advantaged space if you pull the money out.

The 401k is protected under ERISA from creditors, except a domestic relations order.
The Homestead exemption is weaker, and is state by state. A property can be subject to lein/foreclosure/etc.

With a 401k loan, it will be called when you're separated from your employer, and if you are unable to repay it, you will be hit with 10% early withdrawal penalty+taxes.

Refinance, keep making the same payments?

burgerwars said:   Not a dumb question at all. With me, I only owe about $36,000 on my mortgage with a monthly payment of about $700. I have a Roth IRA and 401(k). I figure I can easily take out $36,000 out of my Roth IRA with no penalty since I have more than that in my own contributions and just pay off the mortgage. I reduce my monthly expenses by $700. The chances of me making $700 a month on my $36,000 consistently in my Roth are less than winning the lottery. I'm seriously considering doing this.

You're not 'making' 700 a month by paying off the mortgage, you are 'making' whatever the interest portion of your payment would have been each month for the remainder of the mortgage.

Now if you have a pressing need to reduce your monthly expenses now, maybe it makes sense.

burgerwars said:   Not a dumb question at all. With me, I only owe about $36,000 on my mortgage with a monthly payment of about $700. I have a Roth IRA and 401(k). I figure I can easily take out $36,000 out of my Roth IRA with no penalty since I have more than that in my own contributions and just pay off the mortgage. I reduce my monthly expenses by $700. The chances of me making $700 a month on my $36,000 consistently in my Roth are less than winning the lottery. I'm seriously considering doing this.

Wow, there is so much wrong with this post. You are making your monthly interest payment on your mortgage and nothing more, certainly not $700. You are losing the opportunity to make tax free money on roughly 9 years of Roth Ira investment. Horrible choice.

OK, OP here. Here is where I'm at. Am I approaching this stupidly or am I unaware of anything (double taxation, losing interest deduction on the investment property at the tail end of the term, etc.)?

Assume:
Can't refinance
Decent job security and $28K in cash (plus emergency fund)
Market returns before I pay back loan is <5.25%
*still trying to determine if there is a prepayment penalty, but I don't think there is

Borrow $28K @ 4.77% from 401K and apply to principal OR Keep paying mortgage ($194K @ 5.25%) + pay $250 extra in principal each month OR Keep paying mortgage ($194K @ 5.25%) + pay $28K to principal

$50 loan origination/applicaton fee
$2 monthly maintenance fee

habback said:   OK, OP here. Here is where I'm at. Am I approaching this stupidly or am I unaware of anything (double taxation, losing interest deduction on the investment property at the tail end of the term, etc.)?

Assume:
Can't refinance
Decent job security and $28K in cash (plus emergency fund)
Market returns before I pay back loan is <5.25%
*still trying to determine if there is a prepayment penalty, but I don't think there is

Borrow $28K @ 4.77% from 401K and apply to principal OR Keep paying mortgage ($194K @ 5.25%) + pay $250 extra in principal each month OR Keep paying mortgage ($194K @ 5.25%) + pay $28K to principal

$50 loan origination/applicaton fee
$2 monthly maintenance fee

Is the 28k sitting in a bank earning < 1%? Use that to payoff some of the loan (check to make sure there is no prepayment penalty).

Yes. Sitting in Barclays online savings account.

What is your 401k money invested in (rough asset allocation)?

91% equities, 9% bonds; but the goal here is also to rotate out of equities (and i don't think fixed income is necessarily the right answer in the next 5 years)...

Is the 20K your max loan? By this I mean does borrowing the 20K = 50% of your account balance (typically terms for loans are max of 50K or 50% of your balance. If so, you are cutting off an easy liquidity source for A LOUSY 48 basis points on 20K. Meaning annual "savings" = $96 - $50 setup fee -$24 ($2/month fees) = $22.

I can think of easier ways to earn $22.

Sesq said:   Is the 20K your max loan? By this I mean does borrowing the 20K = 50% of your account balance (typically terms for loans are max of 50K or 50% of your balance. If so, you are cutting off an easy liquidity source for A LOUSY 48 basis points on 20K. Meaning annual "savings" = $96 - $50 setup fee -$24 ($2/month fees) = $22.

I can think of easier ways to earn $22.


Agree with this, but aren't I saving more since I'm paying the interest to myself?

habback said:   Sesq said:   Is the 20K your max loan? By this I mean does borrowing the 20K = 50% of your account balance (typically terms for loans are max of 50K or 50% of your balance. If so, you are cutting off an easy liquidity source for A LOUSY 48 basis points on 20K. Meaning annual "savings" = $96 - $50 setup fee -$24 ($2/month fees) = $22.

I can think of easier ways to earn $22.


Agree with this, but aren't I saving more since I'm paying the interest to myself?

But you will be losing the growth/earnings on the borrowed 20k.

uutxs said:   habback said:   Sesq said:   Is the 20K your max loan? By this I mean does borrowing the 20K = 50% of your account balance (typically terms for loans are max of 50K or 50% of your balance. If so, you are cutting off an easy liquidity source for A LOUSY 48 basis points on 20K. Meaning annual "savings" = $96 - $50 setup fee -$24 ($2/month fees) = $22.

I can think of easier ways to earn $22.


Agree with this, but aren't I saving more since I'm paying the interest to myself?

But you will be losing the growth/earnings on the borrowed 20k.


Gotcha. I think I understand, but correct me if I'm wrong.

I lose the opportunity of the 20K to earn X% over the next 5 years in my 401K. If I assume X>5.25%, I should not do it. If I assume X<5.25%, I should withdraw the money and get the guaranteed return on my outstanding mortgage balance. This lets me take the 20K out of risk in the retirement account, but not necessarily lose the tax-free "space" in the account, since I can repay into it.

habback said:   Sesq said:   Is the 20K your max loan? By this I mean does borrowing the 20K = 50% of your account balance (typically terms for loans are max of 50K or 50% of your balance. If so, you are cutting off an easy liquidity source for A LOUSY 48 basis points on 20K. Meaning annual "savings" = $96 - $50 setup fee -$24 ($2/month fees) = $22.

I can think of easier ways to earn $22.


Agree with this, but aren't I saving more since I'm paying the interest to myself?


No, you financed 20K @ 5.25% now. After your change you have financed 20K @ 4.77% (plus fees).

You can always move your 401(k) investments to cash if you are convinced the market will go down. Your risk of loss is related to your choice of what to invest in. It is not related to how you choose to finance what you have already bought.

ETA - I suppose you have also bought an asset with a 4.77% yield. Still seems pointless to me.

OP - Either your 401k options consist only of CD's and MM's or you're extremely bearish on a market that has been building momentum. YTD my 401k has returned an annualized 33% with 70/30 equity to fixed income ratio. For FY 2012, it returned 18%. I would question pulling money out of a 401k to use for the purpose you indicated.

Keep in mind that 5.25% is truly about 4% after tax deduction comes into play. Honestly I would rather load up on more debt at that kind of long term interest rate rather than paying down anything.

Market return is not risk free but the interest saved from your mortgage is (as in the rate of return is certain). This comes down to your personal risk preference. If you fully understand the consequences (losing the potential market gain, double taxation of the interest, and the possibly of losing your job) and still want to do it as a way of getting out of the stock market, then go for it.

I personally share the same sentiment about the market right now. You just have to look around and ask yourself if the current market situation is as good as early 2007.

thanks all. appreciate the discussion. if it helps anyone else considering, i reasoned that for the 48 basis point spread, i don't want to lose the liquidity in case everything goes to hell at the same time. for me, my investment property is hard enough to refinance and get cash out of, so i don't want too much equity tied up into it right now. i will add $250 month to get at the principal since i have some extra $ earning less than 5 and a quarter.

in 5 years time, i expect i will be in a better liquidity position, but interest rates may be higher. I'd rather sit on the cash and see how things play out.

I'm going to stay the course on the 401k since the horizon is 33 years for me anyway. (unless the FAZ i bought into the close today with my gambling money account works out). cheers.

Mulligan said:   habback said:   I'm not too excited about the stock market right now.

Not really an answer to your question, but...

Shouldn't people, especially at 26, be buying when things are not exciting, and selling when things are?


Shhhh!

You're screwing up my data.

5.25% seems high. 4.5% is available nowadays. Up until a few weeks ago, it was in the 4.25% range.

Skipping 20 Messages...
unnamedone said:   uutxs said:   unnamedone said:   uutxs said:   dl73 said:   depalma13 said:   dl73 said:   You guys need to more carefully read what unnamedone said. He said you pay taxes twice on the interest, not the principal. He is correct.

It's a myth, he's not correct.


Take an example $10k 401k loan, we agree there is no double taxation on that $10k principal you pay back. That is often the myth. But you also contribute into your 401k an additional $700 (for example) in loan interest on top of the $10k, for a total of $10,700. This additional $700 is after tax and isn't tax deductible like the other $10k was. This money is again taxed at withdrawal. So double taxation on the interest, as he said. If the IRS allowed you to deduct the extra 401k loan interest being contributed then you'd be right.

That is all fine. The point is, how is the taxation any different if, you had taken the 10k loan from your bank, at the same terms as the 401k loan, and the 10k that now stays in the 401k earns the same $700 from whatever it is invested in.

Your $700 interest to the bank is still made from after tax dollars. The $700 earnings in the 401k will still be taxed when it is taken out.


There is no myth here, just different perspectives of the same thing. Rather you want to call it double taxation or not, the bottom line is you will pay interest with after-tax money and you will pay tax again when you make distribution. The example you mentioned is just a scenario to justify the tax code. If looking at a 401k loan that way helps you sleep better at night, then go for it.

If the net effect is the same, why label one scenario (401k loan) double taxation but not the other (bank loan). That is where the myth is.


Because you are not borrowing your own money with a bank loan. Maybe you look at it differently, but I consider a 401k loan as a loan to self. Just like you would borrow from your emergency fund, the extra you put back in (if any) is not considered as interest earned.

And again, how you look at it doesn't change how it works. It's like arguing whether the cup is half full or half empty.

You can consider it and describe the loan anyway you like.
Is your tax obligation any different in the two situations. If not, dont label one as more sinister than the other.

Half full and half empty are equivalent.
Double taxation and no double taxation are not.



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