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Should I borrow from my 401(k) to buy a house?

Posted by Cheryl Costa  August 20, 2008 10:07 AM

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My goal is to purchase a home by the age of 50. That gives me four years. Assuming that my salary will grow slightly over the coming years, what do you think about borrowing from my 401(k) to make the down payment? I am single but I have been unable to save much every month. I make $40,000 per year and would like to buy a $200,000 home.

With a salary of $40,000, the monthly payment that you make to cover principal, interest, taxes and insurance (PITI) on your condo should not exceed $1,000. If I assume $200 in property taxes and $50 for homeowners (both pretty conservative estimates), that leaves $750 available for the principal and interest payment. If I further assume a 6 percent mortgage rate and a 30 year fixed term, you can afford a mortgage of approximately $125,000.

That means that you would need to make a down payment close to $75,000. That is a pretty large down payment. If you don't have any savings available elsewhere, and you are looking to borrow that amount from your 401(k), I would advise against doing so for several reasons.

First, there are limits on how much you can borrow from your 401(k). Generally, total outstanding loans cannot exceed the lesser of $50,000 or half of your current account balance. If half your account balance is the lower of the two amounts, a loan of up to $10,000 is possible even if $10,000 is more than half your account balance.

Second, I just hate the idea of having to borrow from a 401(k). Some points to consider:

1. Some plans do not allow you to contribute to a 401(k) while you have a loan outstanding so you would lose any employer provided match, and

2. If you were to leave your employer (voluntarily or involuntarily) the loan would be due immediately. If you failed to repay it within 30 to 60 days, it would count as a premature distribution and be subject to taxes and a penalty.

3. There is also the question of how you would pay the loan back. In my opinion, borrowing from a 401(k) should be an absolute last resort option and if you feel the need to borrow from a 401(k) to afford a house, you probably really can't afford the house.

If you have done a really, really great job of saving in your 401(k), another option might be to decrease or eliminate your contributions to your 401(k) for a very small number of years and accumulate some money that way. If you pursued this option, you would have to be diligent about resuming your contributions as soon as you bought the house. With this option, there is always the danger that you might end up using the money for other needs, and then you would have a smaller retirement account balance and no house, so it has drawbacks as well.

This is a very tough decision because buying a home is certainly an admirable goal. I would just advise you not to extend yourself too far and not to endanger your future retirement. You will certainly find people who will tell you that you can afford a much larger mortgage than $125,000, but don't believe them. Prepare your own budget and determine what seems reasonable for you and your personal circumstances.

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