Using 401 K money to pay off my primary mortgage - Good or bad idea ?

Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes

My story : I'm 30. Fully vested with $55,000 in my 401 K . My primary mortgage has a balance of $35,000 left of my original $182,000 loan I got 5 years ago.I made a lot the past few years during the down economy and was able to pay off my house debt rapidly. I now have a baby ; my wife cut her workload by 75% and I no longer make strong enough income to save enough to pay down my debt any further.

My goal is to have as much monthly savings as possible to build my buy and hold portfolio.

Does it make sense to pay off my home (P&I $950/month) or to leave it in retirement ?

Why or why not ?

Thanks in advance :)

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Destiny Fargher

Eugene, OR · Member since 2014 · 5 posts · 10 votes

12y

Taking an unqualified early distribution from your 401k is a very expensive source of funds. You will pay your marginal tax rate on the funds you withdraw, plus you'll lose another 10% to penalties. It would probably give you warm fuzzies to pay off the last bit of the mortgage, but they will be expensive warm fuzzies and I see little other benefits.

If your goal is to reduce your monthly expenses and save for buy-and-hold properties may I suggest a cash-out refi on your primary residence? You mention your P&I is $950. You could refi to $65k: $35k of existing mortgage, take out $25k for the down payment on a new rental, roll in $5k of the closing costs. Your new payment would be about $350, saving you $600 a month. The closing costs in this scenario are less than the taxes and penalties you'd pay for the 401k distribution, plus you still get to keep your $55k in tact for retirement, plus you can buy a rental right away, plus you reduce your monthly expenses by $600. Win-win-win?

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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
any thoughts ?
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Account Closed
Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
12y
In general its not a good idea. You will pay tax (at least 15%) and penalty of 10% to pull out your money. So right away thats a $10K or greater hit. Second you have given up 30 years of growth on those $55K. At even a very low 4% return, that would give you an extra $120K in your account (total balance of $178K). I would keep the 401K as is and pay off the mortgage in its own time or faster if you find other sources of cash other than the 401k.
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Doug McLeodPro Member
Investor · Cypress, TX · Member since 2014 · 496 posts · 205 votes
12y
You'll do a little better on cash flow (assuming you select the 5 yr payoff of the 401k). It's free (no fees usually) and the tax savings from mortgage interest will not be much of a factor anymore at this point.
However, you could have put the ~$140,000 equity you paid early (I am assuming you had a 30 yr mortgage) into 5-7 single family rentals with each generating $400/mo in cash flow (excl. maint & vacancy) or you could have bought a multi-family property with higher cash flow and potential to double your money tax-free through a value play.
Get that equity back out and put it to work for you (cash-out refinance)! Stop contributing to your 401k and get tax advantaged real-estate income now and even more in retirement.
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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
@Albert Bui @Brie Schmidt @Dawn Anastasi @Jay Hinrichs
Contemplating doing this right away : curious your thoughts.
There is a but if a silver lining here as well. I'm refying 3 of my adjustable rate properties into fixed rate and don't qualify for all the refi's without clearing this debt as well.
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Westin Hudnall:

@Albert Bui @Brie Schmidt @Dawn Anastasi @Jay Hinrichs
Contemplating doing this right away : curious your thoughts.
There is a but if a silver lining here as well. I'm refying 3 of my adjustable rate properties into fixed rate and don't qualify for all the refi's without clearing this debt as well.
Is there enough in a 401k loan option to payoff this "debt," so that you can qualify?
I would check that out first then explore your options to see if you could just restructure that debt into lower payments so that you'll qualify that way. Sometimes when you increase term and decrease rate you can lower monthly cash outflow.
The pros of this is it can free up your 401k policy loan(s) to reinvest else where and the cons is more leverage but, as long as you have enough income coverage you may or may not consider this.
Advantage of 401k loan is it does not hit your debt to income ratios while restructuring your debt with out 401k loans does "hit," your ratios. So it depends on how much income you're Working with, your required investment preferences, how large or small this "debt ," you have to payoff is, and documentable income available.
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Brie SchmidtBusiness Member
Moderator
Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
12y
Albert brings up a good option, can you do a 401k loan to pay off your principle?
I am all for REI and believe in it wholeheartedly, which is why the vast majority of my money is in it, but I never put money in a 401k and I am not sure if I had one that I would pull it out and pay those penalties to do REI.
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Mark Elliott
Investor · west seneca, NY · Member since 2014 · 376 posts · 211 votes
12y
bad idea. using 401k money to pay off a debt??? which one makes more money??? if the mortgage costs you 5% but the 401k gets you 6%, how would you be ahead to save 5% but lose 6%??? let the 401k build and let the mortgage build your credit. you are at less than zero if you pay it off.
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Account Closed
Homeowner · Pittsburgh, PA · Member since 2014 · 854 posts · 511 votes
12y
@Albert Bui @Brie Schmidt
Based on his original post, he does not have enough to go the 401k loan route.
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Mark Elliott:
bad idea. using 401k money to pay off a debt??? which one makes more money??? if the mortgage costs you 5% but the 401k gets you 6%, how would you be ahead to save 5% but lose 6%??? let the 401k build and let the mortgage build your credit. you are at less than zero if you pay it off.
If it was purely just rates it would be an easy equation mark. The view is purely subjective, how do you quantify a guaranteed 5% versus your "hypothetical," 6% yes there is a potential gain and loss each person will have to factor their own appetite for risk/reward to see if it's worth it for them personally.
A loss of 50% in value requires a 100% gain just to break even, should anyone be subjecting their retirement to that risk?
Then the next question is the break even really a break even? What if it took two years and the dollar loss 8% in purchasing power then your still at a loss.
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Account Closed:

@Albert Bui @Brie Schmidt
Based on his original post, he does not have enough to go the 401k loan route.
Then hel'll have to get a bit more creative with out seeing the specific scenario I cannot structure it correctly.
There's all sorts of options out there to obtain capital, optimize debt, credit, and increase cashflow.
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Cal C.
Investor · Peachtree Corners, GA · Member since 2014 · 1k+ posts · 1k+ votes
12y
Taking out a 401k Loan to pay off a small amount left on your mortgage is certainly not a good idea in almost all circumstances. What if you suddenly lost your job and had to repay that loan. Taking the money directly out of your 401k is an even worse idea because of the tax hit and the fact that you no longer have that tax deferred money working for you.
One strategy a lot of people use is to take out a home equity Line of Credit (LOC) on their house use it to buy a property, fix the property and then take out a loan on the repaired property and pay down their home equity LOC. Rinse wash and repeat.
WIth the large amount of equity you have in your home and the super low interest rates this seems like a viable strategy for you as long as you don't overleverage, keep a reserve fund (it could be the home equity LOC) and find real deals.
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Brie Schmidt:
Albert brings up a good option, can you do a 401k loan to pay off your principle?
I am all for REI and believe in it wholeheartedly, which is why the vast majority of my money is in it, but I never put money in a 401k and I am not sure if I had one that I would pull it out and pay those penalties to do REI.
HI Brie,
I was thinking about just enough of a 401k loan not a distribution from the 401k in the "interim," just so he could complete his refinance and then plan for a strategy to pay off the 401k loan after taking the benefit from the refinances. There are credit unions out there that will give up to 80% HELOC's on even non owner properties. This could be one of the ways he could shift the 401k obligation to the HELOC post closing.
Personally I would take the max 401k loan to do REI as well, because I can create way better returns than the risk factored returns of the stock market along with being able to force/create/benefit from increased equity, tax advantages, and cash flow. However, I wouldn't recommend it for everyone.
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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
@Albert Bui
I have $55,000 in my 401 K and would need $35,000 of it to pay off the rest of the mortgage.
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Westin Hudnall:
@Albert Bui
I have $55,000 in my 401 K and would need $35,000 of it to pay off the rest of the mortgage.
Edit: Sorry Westin I reread your original post you were paying off your existing mortgage of 35k to get rid of the 950 payment. The below pertains to overcoming Debt to income and value issues during qualification which is probably less applicable to your scenario. The answer to your question is more a financial planning question. From a mortgage planning perspective if you can shift the payment into your 401k you'll have risk of income taxes if you leave your job but if you think you'll be there and have solid prospects it might be worth that risk. Shifting debt to your 401k will make your DTI look better when qualifying for financing in the future since conventional financing does not consider 401k loans as debt to qualify for. There are other implications too such as growth of these funds and opportunity cost but that could be multiple paragraphs long but short to say it depends on your risk reward preferences.
27,500 401k loan and 7500 gift/title loan/savings/etc
Lets go back to why you have to pay down the loan is it a value issue based on maximum loan to value the bank is willing to lend you or is it an income issue?
If its a value issue you could always renegotiate the appraisal, find better comps, sometimes that up and coming "pending, or latest comp could save your $7500 difference out of pocket you'd have to bring in after the 27,500 401k loan.
If your max loan to value is 75% and the gap is 7500 that means you'll need to document $10,000 ( 10k X 75% = 7500) more in value to reduce your out of pocket cash by 7500 then you'd only need 27,500 from 401k and you can call it a day.
If the reason you have to pay down the loan is due to income qualification then your loan officer should be running scenarios to see if loan paydown is the best option or not. Sometimes paying off the car or other loan with the 401k loan does more to reduce your debt to income(DTI) than the pay down of your loan. Paying down the loan is the hardest way to lower your DTI ratios. For example at 5% rate every $1000 dollars only lowers your mortgage payment by $5.36 per month. If the gap is $125 dollars to qualify to make 45% max DTI you'd need $23,285.20 which is an absurd amount of cash to make 125 per month.
1 Reply
Destiny Fargher
Eugene, OR · Member since 2014 · 5 posts · 10 votes
12y
Taking an unqualified early distribution from your 401k is a very expensive source of funds. You will pay your marginal tax rate on the funds you withdraw, plus you'll lose another 10% to penalties. It would probably give you warm fuzzies to pay off the last bit of the mortgage, but they will be expensive warm fuzzies and I see little other benefits.
If your goal is to reduce your monthly expenses and save for buy-and-hold properties may I suggest a cash-out refi on your primary residence? You mention your P&I is $950. You could refi to $65k: $35k of existing mortgage, take out $25k for the down payment on a new rental, roll in $5k of the closing costs. Your new payment would be about $350, saving you $600 a month. The closing costs in this scenario are less than the taxes and penalties you'd pay for the 401k distribution, plus you still get to keep your $55k in tact for retirement, plus you can buy a rental right away, plus you reduce your monthly expenses by $600. Win-win-win?
2 Reply
Cal C.
Investor · Peachtree Corners, GA · Member since 2014 · 1k+ posts · 1k+ votes
12y
Heloc will likely have much lower closing costs. Yes you might pay higher interest. Rates in the future but I think it is the OP idea to pay off his mortgage over the next few years.
1 Reply
Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
here's my logic : let me know if this makes sense or not everyone or whether there is a better way to achieve my goal:
Goal : buy as many buy and hold properties as possible
Reason : Although my 401k might average 5-10% per year my 9 rentals are averaging over 20% returns per year and with my current salary I can not afford down payments for more rentals but would be able to with my home free and clear. The 3 refi's that I will qualify for with my new debt being removed(paying off primary mortgage) will add $200-$250 cash flow per property per month.
Does this clarify ? Does it seem like a good idea now or still no?
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Account Closed
Homeowner · Pittsburgh, PA · Member since 2014 · 854 posts · 511 votes
12y
Originally posted by @Westin Hudnall:

here's my logic : let me know if this makes sense or not everyone or whether there is a better way to achieve my goal:
Goal : buy as many buy and hold properties as possible
Reason : Although my 401k might average 5-10% per year my 9 rentals are averaging over 20% returns per year and with my current salary I can not afford down payments for more rentals but would be able to with my home free and clear. The 3 refi's that I will qualify for with my new debt being removed(paying off primary mortgage) will add $200-$250 cash flow per property per month.
Does this clarify ? Does it seem like a good idea now or still no?
Why is your yearly average so low in your 401k? What are you invested in?
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Mel Selvidge
Real Estate Agent · Berkeley, CA · Member since 2014 · 55 posts · 40 votes
12y
Do you have a different cash emergency fund? If so, you could use that, and have the 401K as your really bad emergency fund. If not, I'd be worried about running 9 places without some source of readily available cash. You could also try to take a loan against some of your equity.
I'm a Suze Orman fan, and one of the drums that she likes to beat is that a 401K can't be touched in bankruptcy, whereas in CA (don't know what it is in your state), only $100K of your home value can be protected by creditors, and of course, your rental properties are not protected at all.
I like to err on the side of having a cushion if every investment tanked or if my husband lost his paycheck. I guess it's tempting to thing that such things are improbable, but my own house burned down 10 moths after I bought it, and were it not for my boyfriends' parents stepping in with an "emergency fund" things would have turned out differently for us.
I bought an REO from an investor who didn't have enough of a cushion to get him through a couple of bad years, and I guess I don't want to be so maxed that I would fall into the same trap if things went awry.
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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
@Account Closed I'm not savvy in the market .
I honestly don't even look at it unless I see a loss.
I think I'm in the most conservative yet stable option available by my company. pemco tot or something like that
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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
@Cal C.
You are dead on. I have a $120,000 line if credit that I've used to purchase my 9 rentals. The type of higher end rentals I purchase in my market don't produce the amount of equity needed to not have any out of pocket after getting a 75% loan of the rehabbed value on top of the cash/HELOC rental purchase.
That's why I need cash flow. Another thought was to use part of my HELOC to pay off my home but then it would be harder to purchase in cash the type/price of properties I like to buy.
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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
@Albert Bui
Interesting thought you brought up about a loan. Can you explain how a loan works in my instance as I've never heard of a 401k loan. I have $55,000 in the account and am fully vested.
I guess I can refi the amount left on my primary significantly reducing my debt to income then use a loan to purchase 3 or 4 properties ? How much of a loan could I take out if I have $55,000 and what are the typical terms ?
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Westin Hudnall:

@Albert Bui
Interesting thought you brought up about a loan. Can you explain how a loan works in my instance as I've never heard of a 401k loan. I have $55,000 in the account and am fully vested.
I guess I can refi the amount left on my primary significantly reducing my debt to income then use a loan to purchase 3 or 4 properties ? How much of a loan could I take out if I have $55,000 and what are the typical terms ?
Sure the 401k loan does not count as a distribution. A loan is non taxable yet all the responses keep referring to a taxable distribution with fed state and 10% penalty which makes a distribution a horrible idea.
401k loan can be taken in two flavors 5 year term personal and or if you can document its a primary residence you can get a 15 year fixed which makes the cashflow deduction from your paystubs a bearable proposition since a 5 year term presents a much higher payment.
You can borrow 50k or 50% whichever is less at rates around 1 + prime (3.25% since 2009).
You end up paying yourself a 4.25% rate interest and in essence become your own private bank.
The funds are paid back to yourself with after tax dollars deducted from your biweekly or no monthly pay.
Hope that clarifies, I've had borrowers use 401k loans from a variety of administrators such as fidelity, vanguard, nationwide, ING, prudential, and etc and I've seen them bein used for purchase or refinance on primary residences.
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Westin Hudnall
OP
Investor and Real Estate Agent · Maize, KS · Member since 2014 · 270 posts · 53 votes
12y
@Albert Bui
Sounds like the way to go. I found out today I actually owe just 23k ; not 35 as originally thought. So if I have 55k and are allowed to take out 1/2 I will be able to pay off the 23k left.
Then I could pay it back at 4.5 % (or close to) fixed for 15 years wth my interests payments going back 100% to my 401 k.
Am I understanding correctly how this works?
**Sounds to good to be true **
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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
12y
Originally posted by @Westin Hudnall:

@Albert Bui
Sounds like the way to go. I found out today I actually owe just 23k ; not 35 as originally thought. So if I have 55k and are allowed to take out 1/2 I will be able to pay off the 23k left.
Then I could pay it back at 4.5 % (or close to) fixed for 15 years wth my interests payments going back 100% to my 401 k.
Am I understanding correctly how this works?
**Sounds to good to be true **
Yes based on your info that is a good option because by removing the 950 mortgage your dti ratios are greatly improved plus your real life budget is improved as well probably not a full 950 since the auto deduction for the 401k would be around 173 per month if you have the 15year available or 423 with a 5 year term.
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