How to Turn a Cash-Out Refi Into 401(k) Bonanza

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?

Thanks,

-- 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

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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