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I found this topic already (a few years old) but it was very specific to a young person in his 20s just starting out.
What are your thoughts on maxing out a 401k/other retirement savings vs paying down a mortgage early?
It's something I've been considering for when I am finished re-saving my 6 month emergency fund. Right now I am saving for that emergency fund, but when it reaches 6 months of savings, I want to save the money elsewhere. As I see it, I have my 401k (I am already maxing out a ROTH IRA, so I can't add to that) or I can start paying down my mortgage early. I have 28 years on my mortgage, but I can easily make payments that will half that amount to 14 years if i use what I am saving now.
I can see the pluses and minus of both.
For the house, it's a guaranteed investment in that whatever the interest rate is, it's like making a tax free and risk free investment for that amount (in my case, it's just over 3%). It means I will also own a home free and clear in a shorter amount of time and no longer have any payments ever again for a home. Plus, it builds equity in my home.
But for the 401k, I have the potential to make more (it's not guaranteed though as the market may go down). It can also lower my taxes (although even if I max out on my investment, I will still be firmly in the same tax bracket). Plus, I don't intend to stay in my house forever, I intend to sell it and move someplace, someplace smaller when my daughter grows up and goes off to college.
Heck, I could even split the difference and do both (just not put as much in both). For what it's worth, I really can't max out both a 401k and a Roth... I currently save 30% of my income and I am at a good balance between savings and expenses. To max out on both (assuming I stop all other savings--like my daughter college fund and additional short term savings) it will push me over 30% and I don't think that's sustainable for me.
Or maybe I should save elsewhere. After all, both the house and 401k tie up my money so I can't get to it. Maybe instead I should work on 9-12 months of emergency savings first (since I am a single parent after all and have no "backup" if something happens to me).
I'll be honest, I haven't figured out all the tax implications of both options (and I know that's a big thing). But I have time before I reach this decision and I am working on learning about it though.
I would max out 401k, if your mortgage is just over 3%. Mine is 3.875%, and i'm putting extra money into 401k instead of mortgage. Once you factor in the adjusted rate because of the mortgage interest tax writeoff, it's just too easy to beat that % return in a 401k with a diversified fund.
though, maybe being a single parent, you'd find more security from shortening your mortgage term.
honestly, i'd evaluate where you stand as far as your retirement goals. if saving more for retirement doesn't change your retirement situation much, then what good is saving more?
i dialed back my 401k contributions last year when we had our 3rd kid because i'm well ahead of my projections for when i turn 55, 60, and 65. i may increase it at some point this year, but for now, i don't really need to max out, given where i am in relation to my goals.
I didn't see you mention your age, but I personally would direct more funds to the 401k. Over the long term, you can estimate a 7-8% annual return that will grow exponentially with time. I'm not sure you will get that type of return with your home.
I didn't see you mention your age, but I personally would direct more funds to the 401k. Over the long term, you can estimate a 7-8% annual return that will grow exponentially with time. I'm not sure you will get that type of return with your home.
The mortgage and the home should be considered separate for the purpose of this comparison.
Assuming this is a 30yr Fixed, the return is guaranteed at the mortgage rate(excluding tax impact for the moment). Regardless of whether the mortgage is paid off or not, the house is still going to appreciate/depreciate by the same amount.
Let's say someone buys a $200k house with a $160k mortgage at 4%.
Paying down the mortgage reduces interest cost by 4%. This is true regardless of whether the house goes up to $400k, or down to $100k. The interest is simply a monthly expense that can be reduced by "investing" in payind down the principal. Reducing the balance of the mortgage doesn't increase the value of the house at all, so you're not actually investing in the house, you're investing in the mortgage.
The house was invested in as soon as you took ownership.
So, unless you think a 401(k) will do worse than 4%, you're better off with the 401(k).
Tolerance for risk does become a factor as you get older/closer to retirement, but you're usually better off with the 401(k)
If we assume that over the long haul, your investment is going to average more annually than the 3% of your mortgage (a relatively safe bet if you are talking about 30+ years), then the obvious answer is to invest.
The only time I would consider paying down the house first would be
1: If you are upside down and need to pay down enough to sell, but if you have the money, you could just bring it to the table instead.
2: If you intend to live there long enough to pay it off.
Since neither of those sound like they are the case for you, I'd vote to invest.
However, as a single parent, I would definitely suggest you save up a 12 month emergency fund first.
I found this topic already (a few years old) but it was very specific to a young person in his 20s just starting out.
What are your thoughts on maxing out a 401k/other retirement savings vs paying down a mortgage early?
It's something I've been considering for when I am finished re-saving my 6 month emergency fund. Right now I am saving for that emergency fund, but when it reaches 6 months of savings, I want to save the money elsewhere. As I see it, I have my 401k (I am already maxing out a ROTH IRA, so I can't add to that) or I can start paying down my mortgage early. I have 28 years on my mortgage, but I can easily make payments that will half that amount to 14 years if i use what I am saving now.
I can see the pluses and minus of both.
For the house, it's a guaranteed investment in that whatever the interest rate is, it's like making a tax free and risk free investment for that amount (in my case, it's just over 3%). It means I will also own a home free and clear in a shorter amount of time and no longer have any payments ever again for a home. Plus, it builds equity in my home.
guaranteed investment, owning home outright, and equity.
These are not three separate benefits, these are three different ways of looking at the exact same thing - a liability reduction.
I'm not saying it isn't worthwhile, just that you shouldn't make it sound like it has "extra" benefits.
Quote:
Originally Posted by jillabean
But for the 401k, I have the potential to make more (it's not guaranteed though as the market may go down). It can also lower my taxes (although even if I max out on my investment, I will still be firmly in the same tax bracket). Plus, I don't intend to stay in my house forever, I intend to sell it and move someplace, someplace smaller when my daughter grows up and goes off to college.
Heck, I could even split the difference and do both (just not put as much in both). For what it's worth, I really can't max out both a 401k and a Roth... I currently save 30% of my income and I am at a good balance between savings and expenses. To max out on both (assuming I stop all other savings--like my daughter college fund and additional short term savings) it will push me over 30% and I don't think that's sustainable for me.
Or maybe I should save elsewhere. After all, both the house and 401k tie up my money so I can't get to it. Maybe instead I should work on 9-12 months of emergency savings first (since I am a single parent after all and have no "backup" if something happens to me).
I'll be honest, I haven't figured out all the tax implications of both options (and I know that's a big thing). But I have time before I reach this decision and I am working on learning about it though.
You definitely should contribute enough to your 401k and Roth to be on track for your retirement needs, whatever those may be, because otherwise you lose the tax-preferenced space, and this cannot be "made up" later.
Additional amounts after that may, or may not, make sense to throw at the mortgage. First off, if you are going to move at some point, I would say pay down the mortgage rather than saving for another house. You will get the money back when you sell the house anyway and thus have it for the down payment, so it makes sense to earn a 3% return on it in the meantime rather than the 1% you'd earn in a savings account. On a second note, though, if you have any high interest debt, that should be paid down first.
If you're paying PMI, it makes more sense to pay down the mortgage to get rid of it, than it would absent the PMI.
Finally, as a more long-term consideration, paying down your mortgage is like a fixed income investment, so if you can save more interest than you would earn putting the same funds into a fixed income allocation, you should pay down the mortgage (until you have used up all the money that was earmarked for fixed income, then the rest would be invested into stocks.)
In the long run, stocks (and stock mutual funds and ETF's) do better, but they fluctuate in value a lot in the short term - so you would not want to put money in stocks that was going to be used in the near term - less than 5 years. If you will stay in your current home for more than 5 years, then you could consider investing your money in stocks that you will use when you buy another house. If you will stay less than 5 years, you would not want to invest your down payment funds in stocks, and thus you'd be stuck with pretty paltry returns and should pay it into the mortgage rather than putting it in savings and earning a piddly 1%.
If in retirement you will be living off Social Security and your investments, I would make sure the mortgage is paid off before I retired.
But, with a 3-4% interest rate I wouldn't be paying it off early at the expense of investing for a likely higher avg return.
Depends how close you are to retirement.
Actually, inflation becomes your friend when you have a mortgage and SS. Easiest way to see why is to use big numbers. If next year, 100% inflation came into play, you would make twice as much, but spend twice as much on new purchases.
Fixed debt doesn't increase in that situation though. So when the COLA comes along, it actually becomes easier to pay your mortgage.
The people who need to pay down their mortgage are the ones just living off a pile of cash. If your money is invested, typically the dividends/gains trend in the same direction as inflation(as long as it doesn't get too out of control and crash the economy).
So I still think I'd go 401(k) over trying to pay down the mortgage.
and I even asked the same question here.... it's somewhere I'm sure
I got the same answers as above... Thought about it for another 6 months.... and decided it was reasonable advice.
With your interest rate being so low you can do a lot better (7-8% or more) by putting your money in other vehicles other than the house. One of my managed accounts did 14% between Aug 2013 and Aug 2014. It's a gamble, yes, but the idea is to diversify your portfolio. I would look closer at the 401k and see what kind of funds are in it. I personally haven't done it, but even though we max it out, it's not our main investment (which I have far better knowledge of).
The other difference is that we're in a condo and even if we pay off the loan we'll always be paying $500 to two HOA's. There is little incentive to be "debt free' when I'm always and forever going to be paying out, regardless if there is a note or not. It's all psychological I realize, but in a way, so is choosing to pay off the home when more money could be made elsewhere.
If we assume that over the long haul, your investment is going to average more annually than the 3% of your mortgage (a relatively safe bet if you are talking about 30+ years), then the obvious answer is to invest.
The only time I would consider paying down the house first would be
1: If you are upside down and need to pay down enough to sell, but if you have the money, you could just bring it to the table instead.
2: If you intend to live there long enough to pay it off.
Since neither of those sound like they are the case for you, I'd vote to invest.
However, as a single parent, I would definitely suggest you save up a 12 month emergency fund first.
Hmmmmm, not sure I quite agree with #2. The "return" you get on mortgage prepayment is the interest rate, regardless of if you stay in the home until payoff or sell it before that. If your time horizon is long and you are justified in investing aggressively, you would do worse by taking the 3% "return" of mortgage prepayment, regardless of if it is paid off while you are still in the house, or not. The only thing selling the house before paying it off really does is to reduce the amount of time that your prepayment money remains illiquid.
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