Borrowing Money from your 401K when Buying a Home

The days of borrowing 100% when buying a home may be gone.  At least, if the mortgage companies have learned their lessons from the 2008 crash, they should be gone.  Many companies learned that asking for a substantial down-payment is needed to provide some incentive for the home buyers to not just turn in the keys if housing prices decline.

Borrowing 100% of home value has also proven problematic for home buyers because even a minor 5% drop in the value of a house has caused owners to be trapped in the house.  Throw in the loss of a job and a bad situation gets far worse as individuals are unable to move to a location with better employment because they cannot sell their homes in the distressed area.

While it is unpleasant to lose several thousand dollars of a down payment when real estate prices drop, at least if you’ve made a good down payment and have some equity you can sell the house and move if needed.  You can also  buy something else in the new location at a good price, possibly recovering your losses as the real estate market recovers.

Few individuals have the patience and discipline, however, to save up a big down payment, especially 20%.  (Note that a 20% down-payment should be the goal since that allows one to avoid paying PMI on top of the loan interest.)

While most people have little money in the bank, if they have been contributing regularly to their 401K accounts they may have tens of thousands of dollars stored away.   For many people, that money which has built up in their 401K accounts is tempting.   Why not take out $40,000 or so in a loan from the 401k to make a down-payment?

The issue is twofold.  First of all, one loses investment earnings from the 401K while the money is borrowed and not invested.  While this may not seem like much of a concern, given that the market has been flat for the last 10 years, one never knows when the next big bull market will begin.  If you had borrowed money for your down-payment in 1980, thinking that the economy looked sour anyway, you would have missed out on the biggest bull market of the 20th century.

The second issue is that if you lose your job or decide to quit, you must pay back the loan immediately or the loan will be counted as a withdraw, causing taxes and penalties to be due.  On a large loan this could be a significant amount.  One might therefore end up with a huge tax burden or being trapped in a bad job because it would be too costly to quit.

So, while it will take dedication and stamina, it is worth saving up the money for a down-payment.  Remember that your retirement funds are for just that – retirement.  And if you are not able to save up a down-payment, maybe the house you are looking at is out of your price range because it will be difficult to make the payments anyway.  Think about buying a smaller house and moving up in increments or cutting back your lifestyle for a while to save up the needed funds.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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