Borrowing from 401(k) or a loan?

[coody]

I would like to buy a house with cash but still lack $30,000 to close the purchase. Which choice will be more cost saving, borrowing from individual 401(k) account or the home loan? Thanks.

[HomeGuru]

Originally Posted by coody

I would like to buy a house with cash but still lack $30,000 to close the purchase. Which choice will be more cost saving, borrowing from individual 401(k) account or the home loan? Thanks.

**A: not enough details.

[efflandt]

How secure is your job? A loan from a 401k becomes immediately due and payable if you become no longer employed there. The alternative is owing 10% penalty if under age 59.5 and income tax on the unpaid balance. I think a 401k loan has to be paid off within 5 yrs.

Interest on a loan used to purchase a home is usually tax deductable unless you are covered by alternative minimum tax. But interest is NOT deductable if borrowed from a 401k.

While the interest for a 401k loan is payed to your own 401k account, you may end up with less than if that money was compounded in 401k investments unless those investments are doing poorly.

But check with your plan administrator, because some specifics for 401k plans can vary.

[Samm1970]

One thing I'd add is that the payments made on the 401K are pre-taxed, which means it lowers your taxable income. I'd really check with a tax accountant so all pertinent information is taken into consideration.

Get a Good Faith Estimate form the loan broker, then go see an accountant with GFE in hand.

[coody]

Originally Posted by efflandt

How secure is your job? A loan from a 401k becomes immediately due and payable if you become no longer employed there. The alternative is owing 10% penalty if under age 59.5 and income tax on the unpaid balance. I think a 401k loan has to be paid off within 5 yrs.

Interest on a loan used to purchase a home is usually tax deductable unless you are covered by alternative minimum tax. But interest is NOT deductable if borrowed from a 401k.

While the interest for a 401k loan is payed to your own 401k account, you may end up with less than if that money was compounded in 401k investments unless those investments are doing poorly.

But check with your plan administrator, because some specifics for 401k plans can vary.

A good answer. It seems 401(k) is better than the loan, because the paid interest will go to the 401(k) account. Thus, borrowing from 401(k) not only helps purchase of the house but also add the 401(k) funds. The only disadvantage is no tax deductible benefits. However, the tax deductible (if choose the loan) may not exceed the paid interest added to the 401(k), unless one has no ability to pay back to the 401(k) within 5 years.

[HomeGuru]

There may be penalties for early withdrawal of the 401K.

[Samm1970]

A good answer. It seems 401(k) is better than the loan, because the paid interest will go to the 401(k) account. Thus, borrowing from 401(k) not only helps purchase of the house but also add the 401(k) funds. The only disadvantage is no tax deductible benefits. However, the tax deductible (if choose the loan) may not exceed the paid interest added to the 401(k), unless one has no ability to pay back to the 401(k) within 5 years.

If you borrowered the $30,000 outside the 401K for let's say 7.00% and the interest was deductible at say a 25% tax rate, on $30,000 loan that's the equivalent of a 5.25% interes rate. So the question is can you earn more than 5.25% on the $30,000 in your 401K? If so, go with the NON 401K loan because by leaving the $30K in the 401K the interest is compounding and you are earning interest on the difference between the effective rate of 5.25% and the rate of return on the $30,000 in the 401K. That's called an arbitrage. That's how banks make money. They earn more interest on your funds by investing those funds at a greater return then they are paying to borrower them - i.e. the interest paid on savings and checking accounts.

[nextwife]

Over the long term, mortgage money is generally the "cheapest money" you can get. Leave your 401K funds on account to accrue and grow tax free, and likely at far better rates over the next 30 years than the current mortgage rates. Add the negative of tax penalties, and I don't think you should touch your 401k when you can buy at such great rates.

Remember this, any appreciation that occurs on your HOME will occur whether you have 10% or 100% down. It is based upon your market and the home value, not your equity. Whereas, any growth in your 401K WILL depend upon how much you have invested. So the more invested the better your 401k will grow, whereas your home value will go wherever it goes no matter how much cash you you to buy it.

Real Estate is one of the few investments in which you get appreciation on 100% of the value, even if you only have 5% invested in cash.

[Samm1970]

Remember this, any appreciation that occurs on your HOME will occur whether you have 10% or 100% down. It is based upon your market and the home value, not your equity. Whereas, any growth in your 401K WILL depend upon how much you have invested. So the more invested the better your 401k will grow, whereas your home value will go wherever it goes no matter how much cash you you to buy it.

Excellent point!!

[coody]

Originally Posted by nextwife

...Remember this, any appreciation that occurs on your HOME will occur whether you have 10% or 100% down. It is based upon your market and the home value, not your equity. Whereas, any growth in your 401K WILL depend upon how much you have invested. So the more invested the better your 401k will grow, whereas your home value will go wherever it goes no matter how much cash you you to buy it.

Real Estate is one of the few investments in which you get appreciation on 100% of the value, even if you only have 5% invested in cash.

Interesting. Can we say the down payment should be put as less as possible? In other words, borrowing money to buy the house but invest extra cash into the 401K assuming no other investment option.

[Samm1970]

Interesting. Can we say the down payment should be put as less as possible? In other words, borrowing money to buy the house but invest extra cash into the 401K assuming no other investment option.

Yes but of course you want to make sure you can afford the payment. There is another benefit of doing it this way too.

Let's say 2 years from now market values fall a little which they are known to do from time to time. Let's say during this time you are injured and unable to work for a period of time, let's say 6 months. How will you make your monthly mortgage payments if you have all of your liquid money tied up in the property as equity. Since values have decreased and your not bringing home a paycheck do you think a bank's going to want to lend you the funds? Probably not. But, since you have money in your 401K, you could draw against that to continue making your payments and avoid foreclosure.

[nextwife]

One wants enough down to avoid PMI, and then enough additional, IF NEEDED, to make the payment affordable if there is a change of fortune. I also believe in getting a NO-PREPAYMENT penalty 30 year loan, rather than a 15 year, because the OPTION of making that smaller required payment still exists any "short fund" month. I always kick in extra principal, and accelerate my amortization. But continue to also maximize your 401K contributions.

Personally, I'd go for a larger mortgage, if still affordable, and invest the additional money. Even with a conservative mixed portfolio, you'll get a better return than the interest rate on the mortgage costs you. And the money is still accessable in the event of an emergancy situation.