I've received several (actually dozens) of emails asking about whether buyers should borrow money from their 401K accounts to help buy a house. [disclaimer] I'm not a financial expert so don't listen to anything I say! But, here's my opinion anyway.
I looked into this because I'm a little short in my down payment account. Yes, I know if I'd taken a few less vacations last year, I'd be in better shape. I came to the conclusion that this was a bad plan for me. Having a smaller DP and putting up with mortgage insurance for a few years seems like a better way to go. With decent credit you can still get a loan with 10% down as long as you can fully document your income and your DTI is reasonable. You will get stuck with mortgage insurance if your DP is less than 20%. The insurance usually runs around .05%($200/mo on a $400k loan).
I was looking at borrowing $40k for the additional 10% on the down payment. That would lower payments by about $200/mo and save me the $200/mo insurance for a net savings of about $400/mo. However I have to repay the loan. If I choose to repay that $40k over 5 years the monthly payment is $800/mo. So it's costs me an additional $400/mo for the first 5 years. After crunching all the numbers it did not make sense for me to borrow from my 401k.
There are risks and costs involved with Borrowing from your 401K. First off you have to pay it back with interest (which is often credited to your account, so you are paying interest to yourself). You pay it back using after tax dollars though. It does not get paid back using your usual 401k deduction. Then when you pull out that money later you are taxed again. Basically you get taxed twice on that "loan". So it does end up costing you a lot more than a regular loan. If you lose your job, normally you are required to pay the loan off in full. If you cannot that is then treated as a withdrawal and you get taxed on it AND penalized for an early withdrawal. This can be very costly.
Not all companies will allow you to Borrow from your 401K. If yours does not then you have to make a hardship withdrawal. Those are subject to full income taxes on your next years taxes. So you will want to put some of the amount you withdraw into the bank to pay next years taxes.
We are all in different situations and you should probably talk with your 401k administrator and a financial adviser (not some blogger) before pulling cash from your 401K. For me. it did not make sense to consider this path. The costs were too high as were the risks in order to save $200/mo.
Now, let the real financial experts chime in!
14 comments:
Another issue - if you are forced into bankruptcy or into a short sale/foreclosure money still in your 401k is safe but money you've pulled out and put into your house can be taken or lost. One sad story of the crash has been people who pull money out of their 401k's to "save their house" - which of course often ends with them losing both their house AND their retirement savings.
No way, no how would I borrow or take money from my 401k. Your 401k is for food and medicine when you retire, so you don't have to eat dog food or be a WalMart greeter.
Fair, in the last downturn I saw many people on the "slope of hope" spend their entire savings, borrow money from relatives, etc, to keep their upside down homes.
Eventually they threw in the towel and lost it all, making things much worse for them. I know one guy that borrowed against his Mother's home to keep his spec homes going...his Mom still loved him, but his wife divorced him, he lost the Corvette, his huge ego setback a bit..
Neil
I was dumb once and didn't roll over a 401k, it was taxed at 50%. It would have been better if we never contributed to that 401k.
X,
This actually worries me that you are getting so many emails about this. It seems like we have another wave of people ready to make dumb financial decisions. Its that what go us into trouble in the first place?
What happen to just saving the money to buy a home?
I think there are a lot of young people that don't have much saved and see this as there only chance to get into the market. There is still a lot of fear that the prices are somehow going to shoot back up. It's better to try for an FHA loan with a small 3.5% DP than raid your 401k. If you can't save a 3.5% down payment in a year you have no business buying a house. Even on a $400k house that's only $14k. Buy in MoVal and you can get in for less than $10k for a decent house.
You can have a balanced approach borrowing from your 401k account. Reduce the contribution rate, so the 401k repayment doesn't affect your take home pay as much. By the way, your loan repayment is technically the same as a contribution, The savings by not paying mortgage insurance, lower loan amount and enjoying a sweeter mortgage rate easily offset the axtra income tax you need to pay. The future equity of your house will be more beneficial toward your retirement than the unknown performance of a 401K.
L_Thek_Onomics
Sounds great on paper but you repay the 401K with AFTER tax dollars, in other words your 401K loan is NOT tax deductible like a regular mortgage loan is. The mortgage rate will only be different if you have to go Jumbo by not pulling out money. Otherwise it's a wash on the rate in most cases. Again, it depends on the situation but I don't think it will work out in favor of most of the people thinking of doing it.
I see you believe the myth perpetuated by the real estate industry that a home is your best investment. Over the long run real estate barely keeps up with inflation. Factor in maintenance on the home and it's a loser. Over the long run stocks do far better (except times like now). Plus do you plan on living in a box when you retire? Possibly a reverse mortgage to use that equity to live off? What if you outlive the equity? Then what, back to the cardboard box again.
A house is a place to live. Pay it off and you will be as close to worry free as you can be in retirement. But planning of using it as a retirement plan isn't a very wise idea. I know a lot of middle class retirees. And the ones that live the best, lived within their means, saved and paid off their houses.
A better 401K play may be to take the loan out and purchase gold coins. It could be hedge against dollar/bond collapse, and/or 401K seizure by the government. After you've paid yourself back, repeat.
It's better to try for an FHA loan with a small 3.5% DP than raid your 401k. If you can't save a 3.5% down payment in a year you have no business buying a house.
Amen.
Like you say, a lot of people are afraid of house prices soaring again. That's just not going to happen, because house price bottoms are always broad, and we have a ways to go yet apart from the exurbs, which might be nearing their lows (assuming they don't become ghostburbs or there's not another round of economic plunges). Having to save delays a purchase, which is a good thing financially at present.
If you reallyreallyreally HAVE to have a large surburban house, there are a lot of investor purchases going on in the outlying regions now. It's now becoming possible to get a cheap lease on a nice house owned by a real investor who won't get foreclosed on. I suspect they'll be happy to have good tenants right now.
"I see you believe the myth perpetuated by the real estate industry that a home is your best investment."
No, My brain is not infected by the b.s. of used house salesmen. I don't see the real estate as an investment, but more like a piggy bank. The interest you pay (after tax deductions) is a bargain rent rate for the place you live in. The principal payment and any appreciation become a generous savings account by the end of the loan term. After that, is up to you, but most of the time we're talking about a good chunk of money. Now, back to the 401K loan. It's almost the same as using money from your savings. Just like rebuilding the savings account, your 401K will be re-built in maximum five years. The issue is, the cost of money. Paying no mortgage insurance, lower loan amount, sweet interest rate on your 30 years fixed mortgage offsets (hands down) the cost of extra taxes and interest you pay for (maximum five years) on your 401K loan. Just a quick guess, after ten years, you can pocket the difference.
L_Thek_Onomics
With a curve like this, worry about housing pricing going up is zany.
http://tinyurl.com/cqdkkv
Many people will be fooled by the normal "spring fling" where every year, good years and bad, more homes are sold in the first half of the year then the latter.
I say let these people buy, many of them will be foreclosed in 12-18 months as the market continues to go lower. Buyers that buy at the top and when prices are declining are all part of what makes a market. You see this sort of thing in the stock market as well. Citi goes down from 50 to 30 and many buyers come in....catching a falling knife.
There is still a huge hidden inventory, gazillions of homes in pre foreclosure, and the coming supposed sub prime foreclosures coming.
I say wait until the red and blue lines cross on the chart linked above. It may be like watching paint dry, as it will be a couple of years. You should get a better price that way.
On a purely contrarian basis, the fact that there is so much interest on these blogs, so many multiple offers on crap houses and worry about prices going back up...that proves this housing bear is not nearly over.
When the housing mess is truly over, this blog and others will be dead from lack of interest. There will not be multiple offers on any real estate. Housing will be a boring investment, because it's just a place to live. Right now it's a spectacle like OctoMom.
Just my two cents....
Neil
401k loan is very much safer than other loans available in the market. Very recently i have also written a post on financial advice 401k loan
This is a wonderful post. The things given are unanimous and needs to be appreciated by everyone.
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dwilson1707
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