Don't Raid Retirement Savings to Pay the Mortgage

Question: I have two home loans totaling 100% financing. Both are variable rate, interest-only loans. The 80% loan is a 5-year ARM; the 20% loan is a home-equity loan in which the rate changes monthly. I have been in my $389,000 home since July 2004 and I am starting to have trouble making the payments, but I have not missed one yet.

The present value of my home is probably less than what I owe on it, but not greatly so. The only money I have available to continue to make the payments is my 401(k). Should I withdraw funds to stay in the house and sell it when the market turns around? Also, if I do, would the withdrawal be considered a hardship withdrawal in IRS terms?

Answer: The National League of Cities says "No." In a recent release, NLC and ISMA-RC, an independent not-for-profit corporation focused on providing retirement plans and related services for over 800,000 public employees, warned that early withdrawals from retirement savings accounts should be considered only as a last resort.

Apparently, you are not alone in thinking about raiding your retirement savings. Borrowing from 401(k), 457 and other workplace savings programs is on the rise, according to reports from several major financial institutions, and one reason is that people are using the money to make their house payments in an effort to save their homes from being repossessed.

But Gregory Dyson, senior vice president of marketing at ICMA-RC, says such a move can be extremely costly. "It is important for people to remember that building a secure retirement depends on regularly saving money now and not borrowing against their future," he says.

Dyson offers this example: If you receive a $15,000 hardship distribution at age 35 from an account with a balance of $30,000, the cost to you over the course of 30 years, assuming a return on investment of 7%, would be more than $122,000 in lost savings. "That's a very high price to pay for a short-term fix," he says.

Actually, borrowing from an employer-sponsored defined contribution retirement plan can be costly in a variety of ways. If a plan offers a hardship distribution, the withdrawals do not have to be repaid, but taxes and other penalties may be levied. Besides losing the power of compound interest, the loan also might have to be paid back immediately if you change jobs. And if the loan isn't paid back, the remaining balance could be considered a taxable distribution.

For these reasons, the National League of Cities and ICMA-RC are urging city employees and municipalities to seek out several resources that can assist homeowners. Links to these programs, which include Hope Now and NeighborWorks America among others, are also available at http://www.nlc.org/resources_for_cities/homeforeclosure.aspx.

Before you dip into your retirement, try to prioritize your spending. After health care, keeping your home should be your first priority, says Jacob Benaroya, president of Biltmore Capital Group, a company which buys nonperforming mortgages and tries to get borrowers back on the straight and narrow. So make your house payments before your pay on your credit cards or other unsecured debts. Visa can't take your house away from you, but your mortgage holder can.

Also look for optional and unnecessary expenses, things you can give up for awhile. Stuff like cable television, spa memberships and movies every weekend. Every little bit helps, including getting rid of that third car that just sits in the driveway, even if it is your treasured toy sports car.