Dear Dr. Don,
I just refinanced a $65,000 10-year mortgage at 6% with a refi at 2.6% over 10 years with $14,000 cash out. Closing costs were $2,660.
I am interested in putting $10,000 in my 401(k) tax-deferred account at a guaranteed 4.2% yield for at least the next five years. What do you think?
-- Bert Buoyant
Dear Bert, Congratulations! You cut your interest expense by more than half on the outstanding loan balance. Then, you took cash out with a plan to invest in a tax-deferred retirement account at a yield that's higher than the mortgage rate.
The table below shows how the cash-out refinancing has lower total interest expense, even after accounting for the higher loan amount and closing costs. This presumes you have 10 years and $65,000 remaining on your existing 6% fixed-rate mortgage.
Advantages of a Cash-Out Refi
|Existing mortgage||Cash-out first mortgage||Difference|
|Loan term (months)||120||120|
|Total interest expense (pretax)||$21,595.99||$10,799.61||-$10,796.38|
|Estimated closing costs||$ 2,500.00||$2,500.00|
|Total financing costs (pretax)||$21,595.99||$13,299.61||-$8,296.38|
Homeowners typically aren't comfortable borrowing against the equity in their home to invest in the market. But you're planning to lock in a yield on your investments that's higher than the effective interest rate on your mortgage. It's hard to say what the after-tax yield will be on the investment because you're putting the money into a tax-deferred retirement account, and the money won't be taxed until you take distributions.
Generally speaking, you can't just throw money into a 401(k) because those contributions are deferred-wage income. But you can ramp up your 401(k) contributions and use the $10,000 from the cash-out to cover your living expenses. If your employer matches all or part of this additional contribution, you're that much further ahead.
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