Mortgage Tax Implications and Borrowing from 401(k)

[taubel]

Hi - I posted a few weeks ago about setting up a budget to see if we could buy a larger house. I've worked with some basic numbers, and it seems as though we could afford the larger house if we keep to a strict budget.

Does anyone know how I can learn about mortgage and tax implications? For example, say we have a $100K mortgage at 5.25% for 30 years. For our tax return, we "write off" (?) the interest and then I believe we do the same with our property and school taxes, which are around 5K total. We end up with a good sized tax return every year.

If we were to get a $200K mortgage for 4.25% for 30 years and pay $7K/year in property and school taxes, would we then get more money back on our tax return? (Obviously we would be spending a lot more money each month!)

And what about borrowing from a 401(k). I've always thought that was a no-no, but several people have said to do this. If we did use this money for a larger house, I am imagining that the house would be our retirement savings. So that when the kids moved out, and DH and I wanted to retire, we'd need to sell the house in order to have the extra money for retirement. Is this a bad plan?

Who would I speak to - a tax person or a financial planner? Thanks for anyone's advice. DH and I are pretty clueless about financial stuff. (Luckily we're also very frugal and simple when it comes to money.)

[Delicateflower]

Do you even pay enough interest on a $100k mortgage to make it worthwhile itemizing?

"write off" doesn't mean you get it back dollar for dollar. It means you reduce your taxable income by that much, so if your top marginal rate is 25% you'll get a 25% discount on the interest.

[Caneel]

Originally Posted by taubel

And what about borrowing from a 401(k). I've always thought that was a no-no, but several people have said to do this. If we did use this money for a larger house, I am imagining that the house would be our retirement savings. So that when the kids moved out, and DH and I wanted to retire, we'd need to sell the house in order to have the extra money for retirement. Is this a bad plan?

Borrowing from your 401K means you will need to pay that money back to yourself. If you fail to pay it back, it is treated as a withdraw and subject to withholding taxes and a 10% penalty.

Is it a good or bad idea? Depends on so many factors - your risk tolerance, the time value of money, the rate of return on your 401K compared to the cost of borrowing the money elsewhere and so on.

At the simplest level, you are borrowing money from yourself and paying yourself interest as you repay the loan.

I borrowed from my 401K instead of taking out a home equity loan. I paid it back and went on with life. Financially, it was a good decision for us. I have a friend that borrowed from her 401k for the downpayment on her house. Again, it worked great for her.

But you need to ask yourself what would happen if you lost your job? You would need to immediately repay that money or be subject to the taxes and penalties I described above.

Also, will you be able to continue to fund your 401K and repay the 401k loan with a new mortgage factored in? Will you be giving up retirement savings in exchange for a larger house or can you swing both?

[taubel]

Originally Posted by Delicateflower

Do you even pay enough interest on a $100k mortgage to make it worthwhile itemizing?

"write off" doesn't mean you get it back dollar for dollar. It means you reduce your taxable income by that much, so if your top marginal rate is 25% you'll get a 25% discount on the interest.

I have no idea if it's worthwhile itemizing. Our loan is actually for $120, I believe. I'll check with my DH - he does the taxes.

I'm going to look up marginal rate and try to learn what it means for our situation! Thanks for your explanation.

[taubel]

Caneel - We would both hope to continue contributing to our 401k's. Now we are doing 10%. We could just lower that a bit to help us pay the mortgage.

Right now I only work about 10 to 15 hours a week, so I don't put in much money.

We were thinking about borrowing 20K from my 401k, and just leaving my husband's alone.

I do know lots of people at work who have borrowed as hardship loans, which they have up to 5 years to repay. I just don't know of anyone doing it for a house.

Thanks for your help!

[Delicateflower]

The standard deduction is $11,400. Do you even pay that much tax with three children? If you earn $96,000 you'd be paying just on $12,000, maybe, according to the back f this envelope here. I don't think you'll pay enough interest to claim it if you borrow $200,000 at under 5%.

[JudiAU]

Borrowing from the 401k requires repayment so it is a short-term solution. Most plans require repayment within a year. The penalties and fees are very high and it would be especially brutal now, because the market remains depressed. You will probably miss the upswing. I did it once without talking to (future) DH and when he found out and did a spreadsheet that showed me the terrible and expensive error of my ways.