Cash out retirement account or sell and downsize the house to pay off line of credit?

Question

I am in my mid 40's and I have an outstanding secured line of credit with a large balance that I want to clear.

I can only come up with 2 scenarios to clear this amount based on my home equity and retirement savings.

1. Keep the house, but cash in all my retirement. Net of taxes, it will pay off approx. 50% of the line of credit. Then roll the remaining 50% into the balance of my mortgage and chip away.

2. Sell the house. Use the proceeds to payoff the line of credit. I will end up with hopefully a smaller mortgage, but with a much smaller house.

The secured line of credit is that link to the house. I realized also that interest rates on the mortgage vs. line of credit vs. retirement savings should all affect the answer... but this is one of many variables that is a moving target.

In either scenarios, my net asset value will be about the same once the transaction is completed... just one is in house and the other is retirement savings. On the mental side, the idea of not having the line of credit, I think, is a bigger weight off the shoulders than starting all over for retirement savings – but maybe the readers here can shed more insight?

Thanks in advance for your advice and input.

UPDATE thanks for the comments so far.

to answer littleadv i suppose i want to pay it off now so i don't have to deal with monthly payments for the rest of my working life. but from paul's reply i could consolidate but the amount to repay is so large that i rather reduce it with my current assets. maybe this is more emotional vs practical.

Answer 1

If the problem in fact is the emotional tax of paying the LoC, read Buffett & Lynch on emotions before doing anything else.

If your retirement assets are invested properly, ie in small cap value, then you definitely should not touch it. If they're in credit assets, kill em, retirement is a myth with this strategy anyways. You can always invest your retirement properly at any time, but the paragraph after next will give more detail assuming you might.

If the house is in an area that's currently undergoing a housing collapse, don't sell. If it's in an area that currently in a bubble, sell. Move to an area undergoing a collapse if possible.

In general, liquidate any asset with a true expected RoR that is less than or equal to the effective interest rate of the liabilities against it.

In general, if your interest expenses are onerous relative to true expected income, liquidate in order outlined above.

In general, if your income is subject to risk, consider income insurance provided by AFLAC and the like.

imho: the order of financial operations regardless of income should be:

1. income
2. insure income & assets (your body is an asset on your personal balance sheet)
3. investment

Answer 2

JRM, if I were making this decision, I would choose to sell the house (assuming you are not taking a massive loss relative to its market value) and maintain the retirement savings.

From a lifecycle financial planning perspective, both housing and a need to replace your income once you're no longer able to work are basic needs - as long as you are alive, you will need both a place to live and a basic income. However, maintaining your current standard of living, including home ownership, is not a basic need. You have much more flexibility in your choice of housing than in your retirement options. In my opinion, it would be more difficult to make up ground if you choose to start from scratch with your retirement savings than it would be to move back in to a house later if your income allows it. If you cash out your retirement, all future investment returns would be growing from a much smaller base.

From this perspective, I would choose to secure my retirement and let my current standard of living vary according to my earnings over the next 30 working years or so, rather than the other way around.

With a house, every dollar of equity lost now can be bought back later with one dollar of savings. However, there is no prudent way to recover the investment growth that would be lost as a result of the time when you are not invested in the market. So to me, the opportunity cost of selling the house is lower than the cost of cashing out your retirement. Additionally, recent studies in the USA have shown that while home prices in general faster than inflation rise over time, the price of any particular home only rises in step with inflation. The rest of the rise in overall prices is primarily due to the fact that newer homes keep getting larger and nicer. Based on this, it's reasonable to look at a house as a good store of value, but not as a true investment in and of itself, where your investments will likely produce a "real" return after inflation.

Personally, I would prioritize maintaining enough savings to ensure that I would have an adequate future stream of income that takes future inflation into account, as well as any additional needs you're likely to have in retirement, particularly healthcare. One way you could get a feel for this would be to determine your likely retirement age (70 for example), and then get quotes from a few reputable insurance/investment companies on how large of an annual payment you could get from a deferred annuity (beginning at retirement age) with your current savings. If this amount is more than adequate, then it may be appropriate to consider using some of these funds for housing.

For me, the worst case scenario would be having a nice house now but then falling into poverty later if things don't work out over the next 30 years. I'd much rather live more simply now, but know that I'll be ok when I retire. However, this is a difficult personal decision, and it's important that you can emotionally accept the risks and losses of whatever decision you end up making. I'd recommend that you figure out what your worst case scenario is, and then avoid it.

Best of luck!