Author Topic: Should I Borrow from 401(k) for First Time Home Purchase?  (Read 6532 times)

bcronan43

  • 5 O'Clock Shadow
  • *
  • Posts: 4
Should I Borrow from 401(k) for First Time Home Purchase?
« on: August 09, 2013, 06:16:14 PM »
Hey all,

I'm considering borrowing from a 401(k) for a first time home purchase, wondering your thoughts. My plan would be to borrow just enough to avoid paying the PMI, and nothing more. I can borrow up to $50k from the 401k at a rate of 4.25% over 15 years. I plan to live in the place for a minimum of two years and rent one of the rooms out during that time. Afterward I would like the flexibility to move if needed and the ability to cover the mortgage, taxes, HOA and maint. cost with rent. I'm buying in Oregon.

I'm 30 years old, total net worth ~$150k combo of 401k, some individual stocks and some Roth IRA.

I listed some pros and cons that I think are valid to consider:

Pros to using 401k:

[PRO] Avoid Paying PMI

[PRO] It's a way to access pretax savings early, converting them to equity (what affect does this have if I sell in 2 years and take the cash?) Might not be able to get that money so early any other way.

[PRO] (Possibly) is a more conservative investment of my total wealth - improved overall diversification.

[PRO] Instead of paying the bank the interest, I pay myself the interest

Cons to using 401k money:

[CON] Reduces the leverage power of borrowing for the mortgage - If I borrow for the mortgage, and the property value increases, it will increase proportionally to the value of the property, not how much equity I own. If I bought a $100k property with cash  and the property goes up by $20k I make $20k on that $100k investment. If I borrow for the property and it goes up by $20k, but I had only put in $20k equity, I've now doubled that $20k and the $80k that I left in the stock market has earned possibly 10% over the last couple of years.

[CON] I don't believe the interest on the loan that I am paying back to myself is tax deductible, so my total deduction amount is reduced.

[CON] I'll be paying the bank the interest

[CON] (Possible) Takes money out of the 401k, reducing potential gains that the stock market will see

Thank you very much for your time!

Mariel

  • 5 O'Clock Shadow
  • *
  • Posts: 1
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #1 on: August 09, 2013, 11:56:45 PM »
Just a thought or two.

1. Is your job secure? can you pay the loan back if you're let go? Or the penalty and taxes ?

2. You will pay back the loan with after tax money and then be taxed on the money again when it's withdrawn later.

I've had 401k loans and its really good to get your paycheck back when they are over!

ArtieStrongestInTheWorld

  • 5 O'Clock Shadow
  • *
  • Posts: 33
  • Location: Washington, DC
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #2 on: August 10, 2013, 06:04:57 PM »
How long would you have to wait to save enough to put 20% down and avoid PMI?  I assume you have your eye on a particular property.  Is there a reason why that property or a very similar one won't be available when you eventually have the 20% saved up?

Also, why borrow against your 401(k)?  If this is a first time home purchase, I believe you can withdraw up to $10,000 from your IRA penalty free.  Is there enough in your IRA to achieve the 20% down payment?

bcronan43

  • 5 O'Clock Shadow
  • *
  • Posts: 4
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #3 on: August 10, 2013, 08:57:11 PM »
Just a thought or two.

1. Is your job secure? can you pay the loan back if you're let go? Or the penalty and taxes ?

2. You will pay back the loan with after tax money and then be taxed on the money again when it's withdrawn later.

I've had 401k loans and its really good to get your paycheck back when they are over!

Mariel,

1. My job is secure. If I did lose my job I'd probably have to rent the place out and move onto a friend's couch or back home to pay the loan back.

2. Wether I'm paying back the 401k loan or a mortgage loan from another lender I would be paying with after tax money so I don't know if it makes sense to think of getting taxed on that money twice. I'm meditating on that comment.

Thanks for the response.

bcronan43

  • 5 O'Clock Shadow
  • *
  • Posts: 4
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #4 on: August 10, 2013, 09:07:28 PM »
How long would you have to wait to save enough to put 20% down and avoid PMI?  I assume you have your eye on a particular property.  Is there a reason why that property or a very similar one won't be available when you eventually have the 20% saved up?

Also, why borrow against your 401(k)?  If this is a first time home purchase, I believe you can withdraw up to $10,000 from your IRA penalty free.  Is there enough in your IRA to achieve the 20% down payment?

It would probably take me 6-7 months to save enough to cover 20% on an apprx. $200k home. That's counting taking $10k from my Roth IRA. I'm in an area in Portland near a chip fabrication plant where they are building 3 massive new buildings which will be operational within a couple of years. From shopping for a rental to live in I can tell the place is a great rental market as there are a lot of transient workers out here, rental prices are high.

I'm thinking home prices are trending up over the next few years in this area.

ArtieStrongestInTheWorld

  • 5 O'Clock Shadow
  • *
  • Posts: 33
  • Location: Washington, DC
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #5 on: August 11, 2013, 05:37:38 AM »
How long would you have to wait to save enough to put 20% down and avoid PMI?  I assume you have your eye on a particular property.  Is there a reason why that property or a very similar one won't be available when you eventually have the 20% saved up?

Also, why borrow against your 401(k)?  If this is a first time home purchase, I believe you can withdraw up to $10,000 from your IRA penalty free.  Is there enough in your IRA to achieve the 20% down payment?

It would probably take me 6-7 months to save enough to cover 20% on an apprx. $200k home. That's counting taking $10k from my Roth IRA. I'm in an area in Portland near a chip fabrication plant where they are building 3 massive new buildings which will be operational within a couple of years. From shopping for a rental to live in I can tell the place is a great rental market as there are a lot of transient workers out here, rental prices are high.

I'm thinking home prices are trending up over the next few years in this area.

Got it.  If it were me, I think I'd just buckle down and try to save up the money over the next 6 months.  If you could make  some other sacrifices in your budget, you might even be able to do it in a shorter period.  Especially if the new chip fabrication centers are opening up over the next few years, it doesn't sound like your market would be substantially different in the next six months.

Since you think your real estate market is trending up, do you think it's trending up more than 4.25% per year?  If not, you'd be paying more in interest than you'd be gaining in equity over the next six months.

If you do end up borrowing from your 401(k), I'd at least plan to pay this back within 6 months.  Like you said, you're not only paying interest, you're losing how much that money could be gaining in the funds you've chosen.  Good luck with everything, let us know what you decide.
« Last Edit: August 11, 2013, 05:39:55 AM by ArtieStrongestInTheWorld »

hoodedfalcon

  • Bristles
  • ***
  • Posts: 441
  • Location: Deep and Dirty
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #6 on: August 11, 2013, 06:33:47 AM »
I just have to sneak in here and tell ArtieStrongestInTheWorld that I love his screen name almost as much as I like Pete and Pete.

Oh, and I'd vote to save up for the down payment the old fashioned way, and leave the 401(k) alone.

gecko10x

  • Bristles
  • ***
  • Posts: 420
    • SawyerPF
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #7 on: August 11, 2013, 06:43:48 AM »
Don't buy if you only plan to live there for two years. ??
« Last Edit: August 13, 2013, 10:40:09 AM by gecko10x »

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5109
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #8 on: August 11, 2013, 06:52:33 AM »
I will go a little farther.  If you have to borrow the down payment to buy a house, you cannot afford the purchase.  Taking a 401(k) loan demonstrates you have no reserves.  What happens if the roof leaks or the furnace gives out?  There will be plenty of buying opportunities in the future.  Save up a reasonable down payment and some cash reserves.  Leave the 401k and the Roth alone and let them grow.

There's a reason loans at more than 80 percent loan to value require mortgage insurance.  The risk the borrower will default is much higher.  What happens if chip technology changes or manufacturing becomes cheaper somewhere else?  Chip manufacturing requires a huge capital investment, but manufacturers know things change quickly and will shut down plants on fairly short notice.  It's priced into the investment.  There used to be a lot of chip manufacturing here in Silicon Valley.  Today, not much.  If the economy of your local area is heavily dependent on the manufacturing jobs, there is significant risk.

bcronan43

  • 5 O'Clock Shadow
  • *
  • Posts: 4
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #9 on: August 11, 2013, 01:28:13 PM »
Wow thanks everyone for the great responses. It's given me some good perspective.

I naturally lean more towards the freedom of holding all of my investments in 401k, Roth and other non-tax sheltered accounts like Vanguard's mutual funds or a lending club account. I really like the freedom of renting and I'm not very interested in home improvement activities or becoming a landlord tied down to a certain location.

While my job is secure the location is not. Since I'm in construction management I've had jobs (all with the same company) on projects in San Diego, Phoenix and Portland.

I was just thinking I'm not diversifying my portfolio enough if I don't own property, but perhaps using the methods listed above is enough diversification?

Anyways, if I do decide to buy in the future I think I will save up for the minimum 20% down, leaving the 401k and Roth alone.

But one more question for Artie. You said here:


Since you think your real estate market is trending up, do you think it's trending up more than 4.25% per year?  If not, you'd be paying more in interest than you'd be gaining in equity over the next six months.

If you do end up borrowing from your 401(k), I'd at least plan to pay this back within 6 months.  Like you said, you're not only paying interest, you're losing how much that money could be gaining in the funds you've chosen.  Good luck with everything, let us know what you decide.

Correct me if I'm wrong, but I believe the interest I pay on a 401k loan is being paid back to the 401k itself? So I would be paying myself the interest? If that's true then the interest is not "lost" money like it is in a normal mortgage. It's more like 'forced additional savings' to make up for the potential gains that the money could be experiencing in the stock market had I not withdrawn it. If this is not true then the whole post is irrelevant and a 401k loan is the equivalent of a regular mortgage loan.

It's a mind trip to think about borrowing money from yourself. It brings me back to the Pros and Cons I listed above. Do you think those pros and cons are all true and accurate?

Forcus

  • Pencil Stache
  • ****
  • Posts: 714
  • Location: Central Illinois
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #10 on: August 13, 2013, 10:28:48 AM »
While my job is secure the location is not. Since I'm in construction management I've had jobs (all with the same company) on projects in San Diego, Phoenix and Portland.

I quickly skimmed your post but this to me is the defining thought. Being tied down to one spot because of a mortgage sucks. It limits your flexibility. The only reason I would consider buying in your situation is if I was financially able to sell my old place at my leisure or use it as an investment property / rental (or, your company has a relocation policy that makes it VERY favorable to you to own). Since you aren't there yet... renting and saving up as much as possible looks like the solution. And maybe renting some more.

Spork

  • Walrus Stache
  • *******
  • Posts: 5753
    • Spork In The Eye
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #11 on: August 13, 2013, 12:34:23 PM »
Correct me if I'm wrong, but I believe the interest I pay on a 401k loan is being paid back to the 401k itself? So I would be paying myself the interest? If that's true then the interest is not "lost" money like it is in a normal mortgage. It's more like 'forced additional savings' to make up for the potential gains that the money could be experiencing in the stock market had I not withdrawn it. If this is not true then the whole post is irrelevant and a 401k loan is the equivalent of a regular mortgage loan.

It's a mind trip to think about borrowing money from yourself. It brings me back to the Pros and Cons I listed above. Do you think those pros and cons are all true and accurate?

I haven't done the math here....  and if one were going to take out a 401k loan, you definitely need to.   But something in my gut tells me that "loan payment+interest" < "gains on big pile of cash".

I could be totally wrong... and I am sure the numbers are going to swing one way or the other depending on loan amount/interest/401k balance/etc.

Cromacster

  • Handlebar Stache
  • *****
  • Posts: 1696
  • Location: Minnesnowta
Re: Should I Borrow from 401(k) for First Time Home Purchase?
« Reply #12 on: August 14, 2013, 06:44:09 AM »
Just a thought or two.

1. Is your job secure? can you pay the loan back if you're let go? Or the penalty and taxes ?

2. You will pay back the loan with after tax money and then be taxed on the money again when it's withdrawn later.

I've had 401k loans and its really good to get your paycheck back when they are over!

1. My job is secure. If I did lose my job I'd probably have to rent the place out and move onto a friend's couch or back home to pay the loan back.



I can't really tell by your response here, but if you do lose your job with your employer you have to pay back the 401(k) loan in its entirety, not just keep making the payments.  If you can't pay it back you have to pay the taxes and 10% penalty on the amount borrowed to the gov'mt.

As others have stated, borrowing against retirement accounts is almost always a bad idea.

Wow thanks everyone for the great responses. It's given me some good perspective.

I naturally lean more towards the freedom of holding all of my investments in 401k, Roth and other non-tax sheltered accounts like Vanguard's mutual funds or a lending club account. I really like the freedom of renting and I'm not very interested in home improvement activities or becoming a landlord tied down to a certain location

This is key...why are you buying a house?