Down payment blues

January 13, 2007 8:14 AM

I am looking to buy a house in the next 2 years or so. Should I (a) suspend payments to my 401(k) and build up my after-tax cash reserves, or (b) keep making my regular contributions, and borrow against the balance when the time is right?

I've been racking what's left of my brain trying to figure out what option puts me in a better financial situation. I think the basic tax implications are the same. If I assemble cash now, I do it on an after-tax basis. If I borrow against the 401(k), I repay the loan on an after-tax basis. So the solution, it seems, is that I should take the loan on the 401(k) so as to defer my tax liability for as long as possible. Right? Or should I try to aggressively invest my cash and beat the interest rate on 401(k) loans, which is currently 10.25%?

posted by Saucy Intruder to work & money (10 comments total)

Never borrow against your 401k. If you would decide to leave your current job, the loan needs to be repaid within 60 days otherwise it is considered an early withdrawal and the penalties are huge. Also, 10.25% seems high.
I would temporarily suspend contributions and aggressively save the money.
posted by alexmikayla at 8:33 AM on January 13, 2007

I wouldn't aggressively invest money that you plan to use in the next two years.

I would also suggest broadening your options past just your retirement account.

Are there other places you can cut back to start saving? Is it possible to get a second job for a while to increase the money coming in? Do you have family that might be in a position to loan you the money rather than borrowing it from your 401k? Any of those would be better options than discontinuing contributions to your 401k or borrowing from what you have contributed.
posted by willnot at 8:47 AM on January 13, 2007

Not all 401ks require you to repay within 60 days. Mr. JG and I both borrowed against ours. He's since left his job and now has a coupon book to make the monthly payments without penalties or fees. Similarly, if I left, I'd have the same arrangement.

Ask about your employers arrangement in that regards before withdrawing and get it in writing. If you're pleased with the rate of growth with your 401K, you might as well continue to contribute to it pre-tax.
posted by jerseygirl at 9:52 AM on January 13, 2007

If the collateral on your loan is the primary residence, the interest is tax deductible. If it is your 401(k), the interest on the loan is not tax deductible. This is a good reason not to want to have a giant down payment - you can save many thousands of dollars a year this way that otherwise would've gone to Uncle Sam.

You can't effectively borrow, though, to make a bigger down payment than you can afford. Even though the 401(k) loan is fully collateralized, it's still credit, and the lenders will be aware of your obligations to repay it, and you might not be able to qualify for the home loan you need. (And my goodness, 10.25% for a fully-collateralized loan - highway robbery.)

So I'd recommend building up some money outside the 401(k). (But don't reduce your contribution below the point at which your employer is matching, if they match - if you do that, you are throwing money into the garbage can.)
posted by ikkyu2 at 12:09 PM on January 13, 2007

How much of a down payment do you think you'll need? First time home buyers with good credit rarely need anything close to the old standard of 20% to buy a house. I've bought 3 homes and never put more than 10% down. My first house was a FHA backed loan that I think required maybe 3% down. It wasn't much.

I would do some research and figure out exactly what the savings goal is. If your credit is good, I think you'll be surprised at how little cash you'll need to buy a house.

Paying the extra PMI on a highly leveraged mortgage and the payment on a 401K loan might be about the same hit to your monthly cash flow. Since neither is tax deductable, I'd rather leave the retirement money safely tuckced away.
posted by COD at 1:08 PM on January 13, 2007

Since neither is tax deductible

PMI is deductible, as of Jan 1.
posted by Heywood Mogroot at 9:46 PM on January 13, 2007

Some 401k plans allow you to take an early withdrawal for specific uses, like home buying. It's taxable, of course, but you can withdraw up to a certain percentage of your total 401k account. (Not recommending that, just putting that out there. It's a bad idea, IMO.)

(also: 10.25% is a good rate)
posted by schnee at 6:22 AM on January 14, 2007

Suspending a 401(k) is the start of a bad habit. You've been good about retirement savings to date; don't fall out of it to justify a purchase, as you'll likely find reasons to keep it suspended, and in a few years' time you'll regret it.

I'd suggest cutting back living expenses rather than the 401(k). If that's impossible, consider slimming your contribution, perhaps to your employer's match limit, rather than suspending it. Or, even better, wait an extra six months to buy and let both sides of your savings accumulate.
posted by werty at 6:54 AM on January 14, 2007

PMI is deductible, as of Jan 1.

So it is, hot diggity!
Thanks everyone.
posted by Saucy Intruder at 5:32 PM on January 14, 2007

Since everyone seems to be missing the point, in every 401k loan promissory note I've ever seen, the interest rate on a 401k loan is for interest you're paying TO YOURSELF.

Faced with the same choice, I chose to keep contributing to the 401k and then take the loan after a couple of years. That turned out to be a good choice, since the appreciation during that period was much more significant that the appreciation in my taxable accounts (by chance, mostly) and there were no tax consequences.
posted by jcwagner at 1:38 PM on January 17, 2007