Thoughts on Retirement Savings vs. Living Mortgage-Free

[taubel]

First, I am not planning to do this - although it's tempting!

But what are the reasons NOT to do it? It seems like something reasonable to consider given our current economy.

We own a home which we like but is very small. We know in the future (when we can afford it) we will buy a slightly larger home. But with housing prices down and mortgage rates low, I wish we could afford to make this move NOW!

IF we used our retirement savings (401ks, investments) and regular savings combined, we would have enough cash to buy the type of house we want. And then we'd just pay taxes every month, but instead of paying the mortgage, we'd put that money back into retirement savings. 

I'm sure it's a bad idea on many levels. I just wonder since our investments are basically going nowhere right now. And we *could* be living in the house we really want.

[crunchy_mommy]

Basically you'd be wiping out your safety net.

Honestly, I don't think it's a terrible idea. I have a friend that used his 401K to make a substantial down payment. It was what they needed to do.

There are the tax penalties on withdrawing from retirement, and the loss of interest on your investments. You'd have to weigh those costs vs. the cost of mortgage interest. It might make sense in some situations. Or maybe a 50/50 deal would work (taking out half your savings to put toward the house).

Plus mortgage interest is a tax deduction. There would be tons of numbers to run to figure out what makes the most financial sense.

I'm just thinking aloud, it's not something I've put any thought into (we don't have substantial retirement accounts yet, still working on that!)

Obviously depends how old you are too... seems like it would be a better idea for someone in their 20's vs. a couple in their 40's!!

[camprunner]

One of the biggest reasons given is that you can't get back the years of compoundable interest. 

It's tempting though and something that I struggle with. Right now when so many are losing their homes, it would feel wonderful to own ours outright.   Right now it's not nearly as tempting to invest like we should

[Mulvah]

I think it's actually a great idea for some people.  Yes, you would need to "crunch the numbers" and possibly speak to a financial advisor (though if I were a betting gal, I'm going to say most will tell you not to do it) to see if it would be a smart financial decision for you and your family.

[ilovemygirl]

Having a place to live that I own free and clear would be so much more preferable to me than putting money into a so called secure place to have for later when really it's just disappearing overnight. 

It's probably unwise to take money out that's already in a 401k since you will be heavily fined for it ... BUT I'm all for putting all other funds towards a home you are SURE you will live in for a lifetime instead of in a risky retirement fund - especially if you are on the younger side. 

[JudiAU]

It is never a good idea to wipe out your safety net. Let's assume you do and you move into the house you really can't afford. And you loose your job. What happens? Assume the economy remains bad and we perhaps slide into a true depression. You can't sell the house because you can't afford the lose based on even more declining house prices. You can't get a mortgage because the economy stinks and you don't have a job.

And you still want to eat.

[taubel]

It's definitely tempting. Unfortunately, we are in our 40s and not our 20s! I am just tired of putting a chunk of our incomes into something that "may lose value." A house may lose value as well, but at least we'd be using it. 

DH thinks we should reduce our 401(k) contributions to the minimum required to get the company match and then use that extra cash towards the mortgage each month. He also thinks we should buy the house we want (which would still be a very modest house by U.S. standards), and then take enough out of our 401(k)s to make the payments on that house the same as what we are paying for our current home. 

That actually seems like a good idea to me. We'd be doing a little of both, so no option could ever be completely wrong (or completely right, for that matter). 

I guess we'll have to crunch some numbers. Any other thoughts, please pass them on!

[taubel]

Oh, I should also mention that we'd make sure not to completely wipe out our safety net. And we'd have a minimum of 20% equity in the house. We did not have a housing bubble in our area, but homes have definitely lost some value. We bought our house 8 years ago, and it is still worth about $40 to $50K more than we paid for it. But people who bought their houses 5 or 6 years ago, and are now selling them, are listing them for LESS than they paid. It's pretty scary!

[velochic]

I am going to say something that is very profound, but doesn't seem like it unless you absolutely understand it.

You cannot finance your retirement.

That's it.  It's a simple statement, but the implications of it are beyond anything financially that we will ever encounter in our lives.  It should absolutely dictate how you invest in your future.

Please don't touch your 401(k). 

[crunchy_mommy]

Originally Posted by taubel 

It's definitely tempting. Unfortunately, we are in our 40s and not our 20s! I am just tired of putting a chunk of our incomes into something that "may lose value." A house may lose value as well, but at least we'd be using it. 

DH thinks we should reduce our 401(k) contributions to the minimum required to get the company match and then use that extra cash towards the mortgage each month. He also thinks we should buy the house we want (which would still be a very modest house by U.S. standards), and then take enough out of our 401(k)s to make the payments on that house the same as what we are paying for our current home. 

That actually seems like a good idea to me. We'd be doing a little of both, so no option could ever be completely wrong (or completely right, for that matter). 

I guess we'll have to crunch some numbers. Any other thoughts, please pass them on!

Well, with you being in your 40's, I wouldn't touch your 401k at all. You just won't have enough time to build it back up. You are going to need that money.

If your house has gone up $50K, you should be able to sell it & have plenty for a down payment on a slightly bigger but still modest house, I'd think.

The idea of owning a home outright does sound awesome though!

[taubel]

Originally Posted by velochic 

I am going to say something that is very profound, but doesn't seem like it unless you absolutely understand it.

You cannot finance your retirement.

That's it.  It's a simple statement, but the implications of it are beyond anything financially that we will ever encounter in our lives.  It should absolutely dictate how you invest in your future.

Please don't touch your 401(k). 

I agree, and this is something we probably would never do. I just wonder why everyone feels it's better to invest our retirement in 401(k)s than in a home. What if we sold the home 20 years from now, and used that money as part of our retirement. We could downsize to a small ranch or townhome, or rent senior housing.
 

[taubel]

Originally Posted by crunchy_mommy 



Well, with you being in your 40's, I wouldn't touch your 401k at all. You just won't have enough time to build it back up. You are going to need that money.

If your house has gone up $50K, you should be able to sell it & have plenty for a down payment on a slightly bigger but still modest house, I'd think.

The idea of owning a home outright does sound awesome though!

Yes, we would have at least 20% to put down on the type of house we want. BUT the taxes would be higher and the mortgage payments would be higher. We are not comfortable with the higher payments at our current income level.

Maybe we should just reduce the amount of money we put into our 401(k)s each month and put that money towards the higher mortgage payment.

Thanks for everyone's thoughts! 
 

[ItsBasilThyme]

It really depends on how much you're planning to reduce your 401k payments, I think. Most people recommend a minimum of 10% each. If you're talking about reducing contributions to 3-4%, that's probably a really bad idea. Especially since it sounds like you can't afford the house otherwise, so you'd have that reduction for the next 30 years?

I get that the stock market is depressing right now, but unless you already have the majority of your retirement savings in place, you really shouldn't be reducing this late in the game. Plus, if it's a modest home as you say, it's probably not going to help you that much in retirement.

Also, I haven't looked it up recently, but isn't the 401k deduction much better than the mortgage interest deduction, since it impacts your adjusted gross income? This may depend on your specific tax situation, but I think that's usually the case.

[zoebird]

is it possible to just be happy with what you have?

if not, i don't see any reason to not do whatever you want to do with your money. I can imagine that you will work for 30 or more years, can add more into savings and 401k during that time, and possibly have a passive income in your current home -- if you keep it and rent it out to someone. 

my aunt considers her two other properties as part of her retirement. her first she's rented out for about 20 years now. her second she's lived in for that long, and she's now 70 and still working. she bought her third place about 2-3 years ago. That's the only one with a mortgage. 

she still works 3 days a week, and goes between the two homes. She has no intention of not working, but she wants to move down from 3 days a week to two, and split them up (eg, Mon, Thurs) so that she can live from her third home and rent out her second home. These two homes will provide income for her.

each time, she did take out of her retirement savings to get downpayments or what have you, in addition to saving up beyond the down payment, and she aggressively paid off her mortgages -- putting less into savings thereby -- and she's had lean times too, no doubt, but it's ultimately turning out to be a good investment for her overall. 

so, it's an idea.

[velochic]

Originally Posted by taubel 

I agree, and this is something we probably would never do. I just wonder why everyone feels it's better to invest our retirement in 401(k)s than in a home. What if we sold the home 20 years from now, and used that money as part of our retirement. We could downsize to a small ranch or townhome, or rent senior housing.

What if in 20 years that home were completely unsalable?  What if something happened, such as has happened in the last few years, that when you NEED the money, you cannot access it because it is tied up and or worth less than you originally paid?  Don't get me wrong... I think that real estate can and should be part of a balanced retirement portfolio if you have sufficient funds to remain diversified.  However what you are talking about is the equivalent of "putting all your eggs in one basket".  That is a poor financial strategy.  Real estate, stocks, ETFs, bonds, precious metals, commodities, munis... ANYTHING... if it's your sole investment, is not just risky, it's foolish.  With a 401(k), you are also getting a match from your employer.  (If not, you should not be investing through your 401(k) and should be utilizing a Roth IRA... hopefully you are doing both).  A 401(k) allows you to be diversified with your investments.  It grows tax-deferred.  You home's mortgage interest and property tax are tax deductible.  There are a lot of reasons to not pay off your home.  There are good reasons to do so, but NEVER is it a wise decision to use funds that will be penalized, taxed, and will wipe out any gains.  Using your 401(k) for anything short of saving a person's life is not sound financial decision making.

There are also personal reasons you might not want to own your home outright.  This is our situation.  We could pay off our mortgage if we wanted to without touching any retirement savings.  We have the cash to do it.  Right now, though, being liquid is more important to us than owning our home outright.  (Plus we don't owe much and our mortgage payments are very, very low.)  You have to really look at your long-term goals.  Right now, money is cheap (that is, you can borrow it cheaply) and you cannot finance your retirement.  Think on that and you'll probably come to your own conclusions.  Best of luck with your decisions!!

ETA:  With penalties and taxes, you do realize that by using 401(k) funds, you've just increased the price of your home by 40%?  Seriously, if someone were to say to you, "You owe $100,000 on your home, but you have to pay me $140,000 to own it"... would you really do that?  These funds are not 1:1 ratio.  You're not paying $1 for every dollar owed if you use cash from your 401(k)... you're paying $1.40 for every dollar owed.  It's like going into the store to buy a $20 shirt, but being told you have to pay $28 for it.  It just doesn't make sense!  Also, if you are borrowing from your 401(k), do you know that if you lose your job, the entire amount is due to be paid back in 60 days from the date of severance?  that is, if you borrow $100k, are you able to replace that money in two months if necessary.  One more point... you can borrow only up to 50% of your 401(k)... would that be enough to pay off your mortgage in the first place?

Edited by velochic - 8/10/11 at 4:24am

[crunchy_mommy]

Originally Posted by velochic 

What if in 20 years that home were completely unsalable?  What if something happened, such as has happened in the last few years, that when you NEED the money, you cannot access it because it is tied up and or worth less than you originally paid?  Don't get me wrong... I think that real estate can and should be part of a balanced retirement portfolio if you have sufficient funds to remain diversified.  However what you are talking about is the equivalent of "putting all your eggs in one basket".  That is a poor financial strategy. 

This just reminded me, my grandparents relied on their house to fund their retirement. It didn't work out so well. They had a large, nice house on a lot of land and put a lot of money into (necessary) upgrades while they were in the process of selling it. Their house was on the market for YEARS and they finally had to sell it for $200K less than what they'd expected. Fast forward a few years, and they've already used up pretty much everything from the house sale and now need to move in with their son. They can't pay their medical bills, can't travel, can't even live where they want to, and need to rely on their kids for financial help. They really, truly thought their nice home would provide them with financial security.

Originally Posted by velochic 

ETA:  With penalties and taxes, you do realize that by using 401(k) funds, you've just increased the price of your home by 40%?  Seriously, if someone were to say to you, "You owe $100,000 on your home, but you have to pay me $140,000 to own it"... would you really do that?  These funds are not 1:1 ratio.  You're not paying $1 for every dollar owed if you use cash from your 401(k)... you're paying $1.40 for every dollar owed.  It's like going into the store to buy a $20 shirt, but being told you have to pay $28 for it.  It just doesn't make sense! 

But when you get a mortgage, the interest means you end up paying a good 150-200% or more of the purchase price. I'm not sure I fully understood that when we bought our house. I spend way too much time now looking at amortization tables and calculating how much we could save if we pay an extra $2K each year or something (which is a moot point since DH is on unemployment so we can't spare extra to pay down the principal)... In some situations, using the 401k to fund the house might be cheaper... although I imagine for most, it's still not a wise move.

[monkey's mom]

There are financial risks to both.

Writing off mortgage interest while paying interest on the loan is not the win/win that I think many people think it is. Paying a dollar to save 25 cents doesn't put you ahead in the long run.

Putting money into mutal funds is not the "sure thing" that it used to be. Nor is "investing" in one's home.

Both are risks. Both can provide securtity in your retirement.

We chose to pay cash for our last house rather than take out a mortgage and invest the difference. We couldn't see paying interest on the one hand and hoping to gain more interest on the other. We took a lot of heat from a lot of people. And then the market crashed. And suddenly our "risk" didn't seem so risky. lol

I have both a paid for house and a lot of money in investments. What makes me feel more secure? The paid off house, honestly.

In the OP's situation, I don't think the borrowing from 401k to upgrade homes is the smartest decision. Losing an employee match would be crazy. Having to pay back the loan should you lose job would be a very real concern in this economy. Penalties would be significant. So many variables. But in my mind, the conventional wisdoms and history of returns don't apply too much these days and it's wise to consider all options as they pertain to one's individual situation.

[taubel]

Thanks for the rental ideas, Zoebird, but we would not be good landlords! We are not handy, and just don't want the hassle.

Velochick, I see all your points. I guess right now we are diversified, with some money being in our 401(k)s and some being in our house. But that's all we have, besides a savings account. I can't imagine us touching the 401(k) money - I was just wondering how other people felt about that option.

We are both contributing above the match to our 401(k)s so we may be able to reduce them a bit to get more income to pay for a house.

In addition, I am only working 15 hours/week. In the future, I will be able to work full time, so that would significantly increase our income. 

I guess we will just sit tight for a few more months and see what happens. 

Now I have another question about how much to spend on repairs/improvements to a house we plan to sell, but I will start a new thread for that one... :)

[velochic]

Originally Posted by crunchy_mommy 

But when you get a mortgage, the interest means you end up paying a good 150-200% or more of the purchase price. I'm not sure I fully understood that when we bought our house. I spend way too much time now looking at amortization tables and calculating how much we could save if we pay an extra $2K each year or something (which is a moot point since DH is on unemployment so we can't spare extra to pay down the principal)... In some situations, using the 401k to fund the house might be cheaper... although I imagine for most, it's still not a wise move.

No, actually, you don't.  Let's use a round number: $100,000.  Over the course of a typical 30 year loan, calculated at today's rate of 4.5%, you will pay an additional $82,000 on your mortgage loan.  So your house costs you $182,000.  If, however, you have $100,000 in diversified investments, with compounding interest at a fairly reasonable rate of 4% interest over 30 years, you will end up with about $325,000.  So, in truth, taking out that $100,000, you end up with $60,000 after taxes and penalty... and it just cost you close to $150,000 PLUS the taxes and penalties.   It just does NOT make any sense.  Unless you LOSE money over 30 years (which is possible, but not likely if you are smart about how you invest), keeping the mortgage (with today's rates) and continuing with your 401(k) will most assuredly put you ahead.

ETA:  You are probably looking at your total payment instead of just P/I.  You're including taxes and insurance, and those you have to pay no matter if you own outright or have a mortgage.  So, over the course of 30 years, yeah, insurance and taxes are going to double how much you pay, but you have to pay those anyway.

[taubel]

Originally Posted by velochic 

No, actually, you don't.  Let's use a round number: $100,000.  Over the course of a typical 30 year loan, calculated at today's rate of 4.5%, you will pay an additional $82,000 on your mortgage loan.  So your house costs you $182,000.  If, however, you have $100,000 in diversified investments, with compounding interest at a fairly reasonable rate of 4% interest over 30 years, you will end up with about $325,000.  So, in truth, taking out that $100,000, you end up with $60,000 after taxes and penalty... and it just cost you close to $150,000 PLUS the taxes and penalties.   It just does NOT make any sense.  Unless you LOSE money over 30 years (which is possible, but not likely if you are smart about how you invest), keeping the mortgage (with today's rates) and continuing with your 401(k) will most assuredly put you ahead.

ETA:  You are probably looking at your total payment instead of just P/I.  You're including taxes and insurance, and those you have to pay no matter if you own outright or have a mortgage.  So, over the course of 30 years, yeah, insurance and taxes are going to double how much you pay, but you have to pay those anyway.

I WISH my 401(k) could be counted on to earn 4% over 30 years! I can only hope that will happen.

What about inflation? Couldn't that make the house worth more than the money over the next 30 years?