Keep the mortgage or pay off the house?

Don't mess with your 401(k), part II&nsbp

Taking out a lump sum from your 401(k) to pay off a mortgage is a particularly bad idea.

A couple with $50,000 in taxable income who pulls $100,000 out of their 401(k) plans to pay off the mortgage plus enough to pay off the additional taxes will reduce their 401(k) savings by at least $135,000. That's assuming they are older than 59½ so there are no penalties.

Withdrawing from a retirement plan to pay down a mortgage when the retirement plan is 100 percent taxable upon distribution is a lousy idea, says Robert Fragasso, president of The Fragasso Group in Pittsburgh.

"That money is taxed at the individual's highest bracket. You're paying an exorbitant cost to free up money."

The pros of paying off your mortgage
All that said, it's not a bad idea to pay off your mortgage prematurely. If you can swing adding an extra payment every month toward the principal without sacrificing your retirement savings, that might be the ideal approach. Use Bankrate's
mortgage calculator to determine how making extra payments to the principal can shorten the term of your mortgage.

5 reasons a mortgage burning makes sense:
You can get more from a reverse mortgage.
You leave more to your heirs.
You protect yourself from suit.
Make a sure bet.
Peace of mind.

You can get more from a reverse mortgage. If a reverse mortgage is your financial fallback position and you owe money on the property, you must take at least that amount as a lump sum advance at closing and use it to pay off your debt at that time. Therefore, having a paid-off mortgage increases the amount of cash available to you in a single lump sum, credit line or monthly advance.

You leave more to your heirs. If you want to leave the house to your children or someone else who doesn't have a lot of resources, do them a favor and pay off the mortgage. Otherwise, they maybe faced with selling the house whether they want to or not.

You protect yourself from suit. In many states, if you're sued, your home is exempt from judgment. Owning your home outright also can provide some protection from bankruptcy. "One hopes sheltering assets in your home will never pay off, but it's something to consider," says Garrett.

Make a sure bet. Gillette Edmunds, author of "Retire on the House," a book about real estate investing, pooh-poohs the notion that it is smarter to keep a mortgage and invest at a higher interest rate. "The problem is that mortgage interest is a sure thing and the investment isn't," he says. "You could lose everything you invested and still have to pay the mortgage."

Peace of mind. For many people, paying off the mortgage has intangible advantages. "You would never believe how fabulous and freeing it feels to pay off a mortgage," Garrett says. "The psychological benefits are enormous."

-- Updated: Oct. 1, 2007

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