What would be better, the withdrawal of 401k funds or to obtain an home equity loan to pay for wedding expenses?
Q: I am 57 and my husband is 62. We would like to borrow $25,000 to help pay for a wedding for our daughter.
We purchased a townhome in 2004 for $230,000 at an interest rate of 5.25 percent. We both work and my husband gets a pension and Social Security. We have credit scores in the mid 600s to mid 700s.
We spoke with a loan specialist at a bank and his advice was not to refinance as the costs would be too high. He said a home equity loan would be better to avoid the fees. But the home equity loan would not give us enough for the wedding.
My husband suggested that I take money from my 401(k) and pay the penalty and taxes to get the money. Do you think at our age, refinancing would be smart? Also could we consider a reverse mortgage?
A: First of all, congratulations to your daughter. But what you’re doing is thinking about mortgaging your retirement and future financial security in order to help pay for a wedding. You need some good personal finance advice.
We can’t get behind you taking out money from your future to pay for the wedding. If you can’t afford to spend $25,000, you shouldn’t be thinking about raiding your 401(k) or refinancing your home to do it.
Instead, you should be honest with your daughter about what you can truly afford to spend and ask her to reconsider the budget for the wedding. If you can only afford to give her $10,000, then that is exactly what you should contribute. Otherwise, you are hurting yourself in the long run.
But since there are other homeowners in your same position, let’s run down what options exist in this type of situation:
First, reverse mortgages provide you with cash when your home is paid off or almost completely paid off. But they are difficult to get right now, and extremely expensive. More to the point, if you don’t have enough equity to take out a $25,000 home loan, a reverse mortgage will be totally out of the question.
If you had more equity, a home equity line of credit would be a real option. The costs are low, but typically the interest rate is variable. That’s fine for now when interest rates are at historic lows, but could be a real problem if you don’t get this loan paid off quickly.
Refinancing is an option, but it’s expensive. Also, if you borrow more than 80 percent of the home’s value, you’ll pay private mortgage insurance (PMI), which could raise your mortgage payment by more than $100 per month. That would completely offset any savings you’d get from refinancing and you’d have to pay some (or a lot) of costs out of pocket.
You may find a lender willing to bump up the interest rate you might otherwise pay to cover the costs of refinancing your loan. You need to evaluate the length of the loan and the costs of refinancing to see if it is worthwhile for you. If you shop around long enough, you might find a lender willing to refinance you at a substantially lower rate with fees that would fit your budget.
But you don’t want to refinance and add an additional eight years of payments to your loan if you don’t have to. You have about 22 years left on your loan and taking out a new 30-year loan will add thousands of dollars to your payments over those years.
Lastly, it would be a mistake for you to take out money from your retirement account to pay for the wedding. Not only will you pay the 10 percent penalty on the amount you take out, but the $25,000 you take out may bump your tax rate up so if you pay at a tax rate of 25 percent, you will have to pay the $2,500 penalty and a tax of $6,250 for a total of $8,850 in taxes and penalties on a withdrawal of $25,000. That seems like a bad idea.
The smartest idea is to sit down with your daughter and be honest about your financial circumstances. The best gift you can give is to not put your financial future at risk so that one day you have to rely on your daughter and her new husband to bail you out.
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