September 4, 2015 in Investing

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 5 years. What do you think?

Thanks,



— Bert Buoyant

Dear Bert,



If you were a student in 1 of my classes, I’d give you an “A” for the day! This is good news. You have reduced your interest expense on the outstanding loan balance by more than half. Double bonus: Using the cash to invest in a tax-deferred retirement account is providing you with a yield that’s higher than the mortgage rate.

Find the best refinance rates at Bankrate.com

Let’s see the evidence

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 amount Existing mortgage: $65,000 Cash-out first mortgage: $79,000 Difference: $14,000
Interest rate Existing mortgage: 6% Cash-out first mortgage: 2.6% Difference: -3.4%
Loan term (months) Existing mortgage: 120 Cash-out first mortgage: 120
Payment (amortized) Existing mortgage: $721.63 Cash-out first mortgage: $748.33 Difference: $26.70
Total interest expense (pretax) Existing mortgage: $21,595.99 Cash-out first mortgage: $10,799.61 Difference: -$10,796.38
Estimated closing costs Cash-out first mortgage: $ 2,500 Difference: $2,500
Total financing costs (pretax) Existing mortgage: $21,595.99 Cash-out first mortgage: $13,299.61 Difference: -$8,296.38

Gauging the pay out later

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.

ADVERTISEMENT

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.

Get more news, money-saving tips and expert advice by signing up for a free Bankrate newsletter.

Ask the adviser

To ask a question of Dr. Don, go to the “Ask the Experts” page and select one of these topics: “Financing a home,” “Saving & Investing” or “Money.” Read more Dr. Don columns for additional personal finance advice.

Bankrate’s content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate’s Terms of Use.

ADVERTISEMENT
ADVERTISEMENT