401k Withdrawal or Foreclosure: Which is Better?

by Florida's #1 Mortgage Planner on March 12, 2008

Are You Using Your 401k to Pay for Your Mortgage? Many Americans are finding themselves facing potential foreclosure and lack any reasonable means to tap into money besides their 401k funds.  That presents a major dilemma, not just for current finances, but for the long-term financial picture as well.  Rather than debate whether or not these homeowners should have even been in the house in the first place, let’s just look at the choices they have remaining, neither of which are good.

On the one hand, they can just stop making those mortgage payments and set whatever money aside in preparation for the inevitable foreclosure.  Believe it or not, this may make more sense than their other option.  While foreclosure is not a good outcome, their finances may not be totally destroyed in the process.  They may even keep enough liquidity in their control so they can survive in the longer term. 

In many states, such as Florida, foreclosures take a long time and if the homeowner is able to live mortgage free during that time, they can accrue a reasonable savings instead of robbing their retirement and facing the other issues associated with doing that.  In the long-term, they may actually be better off financially.

They other option presented here is that they can withdraw money from their 401k plan to pay for the mortgage.  This is a bad decision on numerous counts. 

For starters, there are penalties for taking the money out prior to age 59 1/2.  Then you still have to pay taxes on the withdrawals and that withdrawal could even send you into a higher tax bracket as well.  So, while you may be taking out some money, you could be left with considerably less, maybe even less than half, of that amount for paying off your mortgage.  If you do use it all for your mortgage, Uncle Sam may be knocking at your door in the near future and that will not be a good meeting.

Another problem with withdrawing from your 401k is that you are robbing from your retirement funds, robbing yourself to pay the bank.  The time value of money shows that you will have to work much harder in the future, even just 5 years down the road, in order to undo what you have done. 

Yet another problem with the 401k solution is whether or not you are simply delaying the inevitable.  If you are not in a position to sell the property or refinance quickly, you may be throwing good money after bad and simply “wasting” it away.

Don’t get me wrong, I am not condoning walking away from your obligations, but rather showing you of these two choices, you need to really think about their consequences and look at the long term picture, not just current reality.

There also may be other options you have not thought of yet.  Make sure you are thinking clearly and not during a “panicky” state or you will likely make the wrong choices.  Clear minds and a thorough thought process are required to make the best decision(s) for you and your family.

I am sure that many of you have something to say about this topic, so please chime in.

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  401k Withdrawal or Foreclosure: Which is Better? — IRA 401k
March 14, 2008 at 12:58 am

{ 11 comments… read them below or add one }

Luis August 5, 2008 at 12:59 pm

My question concerning the 401k is, Can the bank go after the 401K savings you have after they sell the house which in this market chances are you will still owe the difference?

Thanks

Robert D. Ashby August 11, 2008 at 10:29 am

Luis,

Good question. The answer to that is no. The bank is only entitled to the property it owns the mortgage on. If the bank is unable to recover the full loan amount through the sale (whether auction or other means), they take a loss for the difference. They cannot go after a 401k or anything else since they do not have a vested interest in them.

Thanks for the question.

Jolinda August 29, 2008 at 1:27 am

I have a small loan out with my 401k, my home is in foreclosuer I want to save my home but my company said that I have to pay the first loan off in order to get a new loan isn’t this against the law because this is a hardship for me and my family, and that is the only option that I have to keep me and my family from being on the street please answer?

Florida's #1 Mortgage Planner September 10, 2008 at 5:56 pm

@ Jolinda – You touched on an area I am not very familiar with, so I am not the best person to ask. My understanding of 401ks and loans on them are that it is on a per company basis, but I may be wrong. I will try to look into more if I can find the time and contact you with a better answer.

Kris January 24, 2009 at 11:13 pm

If we own a home that may go into foreclosure, should we stop contributing to our 401K?

Florida's #1 Mortgage Planner January 26, 2009 at 10:36 am

Kris,

The simple answer to this is…NO. However that depends on your situation, and especially your ability to save your home through not contributing money to your 401(k). If you can save your home, do so. If not, you should keep investing for the future. Another option is to not contribute to your 401(k) and build your more “liquid” reserves.

Again, the real answer depends on your particular situation.

nancy February 7, 2009 at 5:07 pm

Everyone keeps talking about retaining the 401k for future security but mine (don’t know about yours) hasn’t gained any value in the last 8 years, rather it’s lost value (lot’s of it).. What kind of investment value (or security) is that?

My husband was laid off from his high-paying corporate job in 2001. His 401k was worth $125k at that time. At the supposedly “normal” gains of 10% a year (what a bunch of crock) it should have doubled by now (according to all the financial wizards)…

Soon after 9/11 the $125k dipped to $90k. It took until mid-2008 to build to $125k again, but six (short months) later, it has dipped to $100k and the market is still moving downward. Pretty discouraging (and scary).

So exactly how much “security” and investment it is worth, seems at this point, zippo… The financial investors can run off their mouths all they want about what a bad idea it is to pay off the mortgage early but they’re all wet. According to them, the best “plan” is to pay the bank huge amounts of interest (on your mortgage) and invest as much money as you can in your 401K.

Well, you might say, I’m seeing through this little investment banker scheme and have realized the best investment I can make is to pay my mortgage off early…

That way the bankers can go … themselves (I’m sure you know what I mean) and the stockbrokers can also do the same..

I’m holding on to my own money in the form of hardcore assets (property, etc.). That way no one can rip me off again. Plus, I don’t care if the value of the property goes up or down, I’ll have a paid-off roof over my head and no one jacking my money around ever again!

jeff May 10, 2009 at 6:51 pm

We are in the process of buying a new home and the morgatage company wants the terms and conditions of our 401ks. Does this mean that if in the future we for some reason default on our morgatage they can go after our retirement funds? Is this now a common practice of morgatage companies do to the recent housing crisis we found ourselves in?

Robert D. Ashby June 4, 2009 at 4:51 pm

@Nancy – I can certainly respect your analysis, but all of your investing shouldn’t be in your 401(k) anyway and while having a mortgage paid off right now would be nice, you need to at least balance it with savings and other liquidable assets in order to protect yourself financially. One other thing to remember is you never lose money until you sell, so if you cashed out your 401(k) to pay off the mortgage, not only do you incur a 10% penalty, not to mention all of the money is added to your annual income for taxes which could send your tax liability through the roof, but you will take a loss, of which only $3,000 can be written off.

There is a lot of factors that need to go into analyzing the decision, most of which doesn’t sound like you have done. Making decisions based on your emotions will always lead to the wrong decision. Be careful.

@Jeff – Just because the mortgage company is asking for your 401(k) info does not mean they can take it from you. Simply put, they can’t. Rather, as part of the mortgage approval process, the lender does want to know your ability to repay the loan and having assets in a 401(k) adds to that ability and makes it easier to obtain the mortgage, as well as improves your chances of getting the best rate possible. Let me know if you have any additional questions.

steve July 12, 2009 at 4:03 pm

I’m beginning to feel more and more like Nancy as my 401k goes up in smoke. I’m not going to quit investing in retirement, I’ll do what the company matches…but nothing extra. I religiously added extra, but I’m diverting that to mortgage from now on. I don’t like the dishonesty in the wall street types and the government failing to let a free economy play out. All these things affect stocks beyond what we have control over. Not good to me.

Frank July 25, 2009 at 9:47 pm

Well. I am in the process of thinking of taking out a loan from my 401 k to reduce my revolving credit (credit cards, car loan, overdraft protection etc.) so I can eliminate the possibilty of foreclosure. I live in Las Vegas, Nevada and the situattion here is horrible. Unemployment hovering around 13%, top 3 stated in foreclosures and of course terrible eduction. I am considering starting foreclosure and force my bank to work with me on refinancing. I have contacted them for a loan modification and all the other programs, even a law firm who requested $3500.00 to get me going on some type of negotiations with my banker, but with no guarantees. I want to do the right thing. So far, I have talked to many people and they say to be late on the payments, save the money and let the bankers come and try to offer me and affordable mortgage program. They mentioned that the bank cannot take the house unless you agree. My house is approximately $70,000.00 upside down with an interest of 6%. I would need to borrow from my 401k about $26,000.00 to eliminate revolving credit and make it easier to pay the mortgage. My mortgage is currently $2300.00 monthly. Oh, I forgot I have two teenagers so we all no that is also a priority (college). Thanks and maybe somebody can chime in and recommend.

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