Earlier this week, a long-time commenter named Carlos (aka CharlieBoy) mentioned that he paid off his mortgage early. Having done the same thing myself, I was intrigued, so I sent him a note asking for details.
Within a few hours, Carlos sent a lengthy reply with tons of details. Today, I’ll be summarizing his story.
“My wife and I purchased our house in the fall of 2008 for $300, 000. I believe the interest rate was 6%. We used the equity from our old house to pay off three small auto loans and to make a 35% down payment on our new house. The big down payment made it easy for us to refinance it two times since 2008 because we were never under water.
We didn’t want to buy a huge house with a huge mortgage. We decided not to let the bank or agent tell us how much house we could afford. WE did the math, WE knew our budget; therefore, WE decided how much we were comfortable paying each month. We found a house that works well for us within our budget.
Sure, it doesn’t have the desirable three-car garage that we wish we had, but a bigger garage comes with even a bigger mortgage, so we decided we could live with a smaller garage but with the smaller mortgage. […] Back in 2008 the bank would have let us borrow two times the amount that we borrowed. Ouch!”
That’s quite impressive… They paid paid off a $195k (= $300k – 35% down payment) mortgage in about three years. But how? Well, a big part of it was the decision to downsize so they could pay off those three auto loans and put up a big, fat 35% down payment. But there’s more…
“Just a few weeks after we bought the house in 2008, we refinanced our mortgage into a 5%, 15-year loan. To make up for the larger monthly payment of a 15-year mortgage, we had to make some budget cuts. It wasn’t too hard because we no longer had car payments. We don’t go to regular restaurants, and we rarely go to movie theaters.
Last December, we refinanced it again at 3.75%. That was our Christmas gift to ourselves. That lowered our monthly payment once again, but the thought of spending the next 15 years slaving away for a mortgage company continued to bother me every day, we started saving even more to pay it down faster.
By living below our means, we started sending every extra penny we saved to pay down our mortgage principal after we saved a little for emergencies.”
Okay, they refinanced to more agreeable terms, scraped up additional money for extra mortgage payments, etc. But still, how so fast?
“The extra payments towards the principal were making a huge difference, but then something else happened. In April, I changed jobs, which meant I had to decide what I wanted to do with my 401(k). I kept going back and fourth between cashing it out to pay off my mortgage or just rolling it over to an IRA.
I know very well that cashing out your 401(k) to invest in a 3.75% mortgage is not considered wise when you look at the stock market’s historic returns of 7% to 8%. I don’t even recommend it to anybody.”
Yikes. Cashing out a retirement account early results in a hefty tax bill plus 10% early distribution penalty. Ouch. So why did he do it?
Well, he went on to argue that, due to our country’s massive deficits and the political mess that has developed over the past few years, the investment outlook in this country just isn’t that good, and he’s not expecting anywhere near historic returns for the foreseeable future. Given an expectation of low returns, he could justify taking the hit to get out from under his mortgage.
This is a pretty extreme view, and Carlos is well aware of that. After all, he explicitly states that he doesn’t necessarily recommend this course of action to others. But it was the right decision for him.
“By not having a mortgage, I can now focus more aggressively on my retirement. Who knows, I might save enough money to invest in a small business. Not having a mortgage will create more opportunities for me. Getting rid of my biggest financial responsibility makes sense in every way to me.”
Having paid off a mortgage myself, I can say with certainty that it does free up a lot of cash and provide a lot of flexibility. That being said, trading your 401(k) for a mortgage-free life isn’t a decision to be made lightly. Given that contributions to retirement accounts are capped on an annual basis, Carlos will have to work extra hard to rebuild his retirement nest egg.
Sure, he’ll be able to pour money into a tax-efficient (but taxable) portfolio to complement the money he’s able to stash in retirement accounts, but he’s lost a bunch of tax-advantaged space (not to mention the 10% penalty) that he can’t easily re-gain.
So… What do you think? Is Carlos crazy for cashing out his 401(k)? Or crazy like a fox? As much as I disagree with the decision to liquidate his 401(k), I have a feeling that Carlos is going to be just fine in the long run.