Invest in 401k as opposed to paying off mortgage early?

I currently have a 160k Mortgage on my first house with a 3.5% interest rate. I pay my mortgage every month, and pay an extra 1/12 in principal so at year end I pretty much made an extra mortgage payment.

My co-worker sent me a link to this article, http://shine.yahoo.com/financiall...00205.html - in item #4 it states:

"Money Mistake #4: You Started to Pay Extra on Your Mortgage to Pay Off Your House Early
Paying off your house early sounds like a financially smart move. And it's hard to put a price on peace of mind. But a study by two University of Texas professors and a Federal Reserve banker found that diverting that money instead to a 401(k) was a better move. It's a long academic study, but the key is this: You pay off your mortgage with after-tax dollars, which means that for every $1 you make, only 70 cents or so goes to the bank.

Solution: Contribute pre-tax dollars to your 401(k), so the full buck goes in. Make that $1.50 if you get a company match. As that money compounds over the years, you come out far ahead. "

That struck me as kind of odd, but kind of made sense as well. Especially if i can secure more than 3.5% return on 401k then I would be in better shape.

Any SD'ers have experience with this? Or some evidence that I can refute this article with. Appreciate it.

Cheers

EDIT:

Wow, thanks for all the responses.

I will provide a little more information about my home loan if others are interested.

I am 23 years old, I built the house new, closed in November of last year.
Loan is done FHA at 3.5% fixed for 30 years.

Mortgage payment is 1027.9, each month I pay 1113.33 to Chase.

So $85.64 is the extra money I could invest in other things.


EDIT 2:

More loan info as requested.

Student Loan: 3.4k @ 6.80%
Car Loan: 4.8k @ 7.49%

No credit card debt to speak of.

Not sure on your tax situation but here's my thoughts on what you should pay off in order:

1.) Pay off car loan. This is your highest interest and it's not deductible. Clearing out this monthly obligation ASAP will help to accelerate you to save up more each month to pay off other debt.

2.) If your company offer any matching on 401k contributions, make sure you max that out by contributing the minimum it takes to reach the "matchable amount". After you've maxed out any matching from them, move on to step 3. (Some might say that this should be step 1, but i think the interest rate is too high on your car loan and dropping your monthly obligation from that will help you better in the short-term.)

3.) Pay off student loan. This is your next highest interest and while it might be deductible, even after any breaks, it still will be considerably higher than the interest on your mortgage.

4.) Figure out exactly what it takes to kill your mortgage insurance. Paying down your loan enough to get rid of this unnecessary expense will also have the benefit of dropping your monthly payment.

5.) Save up enough until you have enough money in a slush fund to cover you for 6 months of expenses. (Some of the more risk averse people might say this step should be higher.)

6.) If you feel confident about the market, contribute any remaining money to your 401k until you max that out. If you feel unsure, do a mix of 401k contributions and extra money towards your principal.

7.) Now that you've paid off all other debt and maxed out your yearly 401k contribution, put any extra money towards the principal on your mortgage. If you're risk averse or very concerned about the market and the prospects of your 401k accumulating any money, then this should be step 6 instead.

Not sure on your tax situation but here's my thoughts on what you should pay off in order:

1.) Pay off car loan. This is your highest interest and it's not deductible. Clearing out this monthly obligation ASAP will help to accelerate you to save up more each month to pay off other debt.

2.) If your company offer any matching on 401k contributions, make sure you max that out by contributing the minimum it takes to reach the "matchable amount". After you've maxed out any matching from them, move on to step 3. (Some might say that this should be step 1, but i think the interest rate is too high on your car loan and dropping your monthly obligation from that will help you better in the short-term.)

3.) Pay off student loan. This is your next highest interest and while it might be deductible, even after any breaks, it still will be considerably higher than the interest on your mortgage.

4.) Figure out exactly what it takes to kill your mortgage insurance. Paying down your loan enough to get rid of this unnecessary expense will also have the benefit of dropping your monthly payment.

5.) Save up enough until you have enough money in a slush fund to cover you for 6 months of expenses. (Some of the more risk averse people might say this step should be higher.)

6.) If you feel confident about the market, contribute any remaining money to your 401k until you max that out. If you feel unsure, do a mix of 401k contributions and extra money towards your principal.

7.) Now that you've paid off all other debt and maxed out your yearly 401k contribution, put any extra money towards the principal on your mortgage. If you're risk averse or very concerned about the market and the prospects of your 401k accumulating any money, then this should be step 6 instead.

4.) Figure out exactly what it takes to kill your mortgage insurance. Paying down your loan enough to get rid of this unnecessary expense will also have the benefit of dropping your monthly payment.

5.) Save up enough until you have enough money in a slush fund to cover you for 6 months of expenses. (Some of the more risk averse people might say this step should be higher.)

6.) If you feel confident about the market, contribute any remaining money to your 401k until you max that out. If you feel unsure, do a mix of 401k contributions and extra money towards your principal.

7.) Now that you've paid off all other debt and maxed out your yearly 401k contribution, put any extra money towards the principal on your mortgage. If you're risk averse or very concerned about the market and the prospects of your 401k accumulating any money, then this should be step 6 instead.

I'm really glad the general concensus on my situation is pretty much the same. I am going to follow this advice to the T. Sounds like I was taking the wrong course of action on this, so I am glad I asked. Thankfully I haven't been making car loan/mortgage payments more than a couple months.

+repped.

Hitpoint will not be able to drop MIP for another 4 1/2 years regardless of how much equity he has in his home.

This is solid advice, especially the bold part in step 1. Even if the interest payment were lower than some other loans, killing off another monthly obligation can be HUGE.

The only thing i'd change is number 6, I would suggest a roth IRA if you fit the requirements instead of filling your 401k for all the reasons SD'ers like roth IRAs.

I don't know why anyone would pay off a low interest tax deductible loan before a high interest car loan.

Good thing we have Social Security, because it seems like most people are more incompetent than the government when it comes to managing money.

Did you read the thread at all? I was somewhat offended by your post.

I applaud the OP for asking. I work with people on their finances every day - and I agree that most people don't have much clarity in regards to managing their finances. I do, however, think that most people are concerned with not being sure they're taking the best course of action.

Many people don't have the time or energy to commit to studying a second trade (such as the financial industry) and do not know what products are available and the costs/benefits of each one. Some people, such as in this thread, ask for help. Educated peer input is a very positive way to develop any skill set.

Also, OP, don't count on Social Security. Only a fool would think this Ponzi scheme system will carry them through retirement like it does for many current retirees. If it is still available when you qualify, it won't be the large amounts currently collected.

My post was meant to be offensive. People need a wake up call. Did you know that households headed by a person under 35 has an average net worth of only $3,662, down 68% from '84 after adjusting for inflation?
http://pewresearch.org/pubs/2124/...wealth-gap

At this rate, generation X, Y, and Z are screwed even if SS is fixed.

My post was meant to be offensive. People need a wake up call. Did you know that households headed by a person under 35 has an average net worth of only $3,662, down 68% from '84 after adjusting for inflation?
http://pewresearch.org/pubs/2124/...wealth-gap

At this rate, generation X, Y, and Z are screwed even if SS is fixed.

Textbook would say the 401k. Common sense and reality would say the Mortgage. I say pay the mortgage.

I'm really glad the general concensus on my situation is pretty much the same. I am going to follow this advice to the T. Sounds like I was taking the wrong course of action on this, so I am glad I asked. Thankfully I haven't been making car loan/mortgage payments more than a couple months.

+repped.

Truth is, you'd be lucky to get .25% on your money right now in any kind of cash investment vehicle. As far as investments, I think you will see most people have lost almost as much as they have made in the past 5+ years in the market. 25% gain plus 25% gain plus 25% gain minus 95% loss = overall loss. So again, follow the textbook advice if you want, but if your mortgage is paid off, you have 80% of your mortgage payment to do what you want with. AND you could work any job you want without a mortgage over your head. AND your home equity grows at a decent rate since you are $300k tax free when you sell your house down the road. Every investment accept the Roth will take tax out of your pocket when you withdraw. You also cannot put a price on the piece of mind of not having a mortgage.

Conventional wisdom would indicate the 401k first.

Most people that will advise you to do that are broke.

Mortgage first.