Dear Dr. Don,
I'm 57 and hope to retire in about nine years. I need help getting my finances in order, and I was looking for advice on what to do with any spare cash. Would it be better to pay off my mortgage early, or should I try to boost my 401(k)?
I have about $175,000 in my 401(k) plan. Meanwhile, my mortgage has about 23 years left at 6 percent interest with a loan balance of about $120,000. My lender has appraised the house at $125,000 and isn't interested in working with me on refinancing the mortgage.
Thanks for your help,
-- Bob Bifunctional
Dear Bob,
Try to do both. Paying off your house prior to retirement is a sound financial goal, but I'd like to see you have a higher balance in your retirement account, too.
I suspect that your company is matching part of your contributions to the 401(k) plan. Companies usually contribute 50 cents for every $1 you contribute, and they'll match that contribution for up to 6 percent of your salary. Check with your plan administrator to confirm whether you're receiving a company match like this. If so, then at a minimum, you'll want to contribute up to the matching limit. That's free money, and you don't want to leave it on the table.
You also need to find a way to refinance your mortgage. A $120,000 mortgage at 6 percent is too expensive, given that average 15-year mortgage rates were at 2.89 percent at the time this article was written, according to Bankrate.
Should I refinance my mortgage?
| Existing mortgage | Refinancing | Difference | |
| Loan amount: | $120,000 | $120,000 | |
| Interest rate: | 6% | 2.89% | 3.11% |
| Loan term (months): | 276 | 180 | 96 |
| Total monthly mortgage payment: | $802.62 | $822.36 | -$19.74 |
| Total interest expense: | $101,522.19 | $28,025.57 | $73,496.62 |
The table shows that you can save about $73,497 in pretax interest and shorten your loan by eight years if you refinance and pay an extra $19.74 per month. You may be able to get an even better interest rate on a 10-year mortgage. If you can, then take that route versus paying additional principal payments on a 15-year mortgage.
I've ignored closing costs, the possible loss of a mortgage interest deduction on your income taxes and the potential investment return from investing the additional principal payment into your 401(k) plan. That said, this table still makes for a compelling argument as to why you should refinance.
Your lender isn't the only game in town when it comes to refinancing, by the way. You may be able to refinance your home through a Federal Housing Administration refinancing program. You also may be able to refinance through the Home Affordable Refinance Program, or HARP.
Alternately, you could use a 401(k) plan loan to come up with the additional cash at closing to refinance using conventional financing. There's some risk with this approach because the loan becomes immediately due and payable if you separate from your workplace.
Once you've arranged for the refinancing, you can put additional funds into your 401(k) plan.
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