1st time home buyer considering 401K loan - Thoughts?

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PlayingLife
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1st time home buyer considering 401K loan - Thoughts?

Post by PlayingLife »

My wife and I are looking to become 1st time home buyers and are eyeing up a $500K home in our HCOL area. Right now we have $75K in liquid cash, are putting 12% of earnings into retirement funds, and net $8K a month (about $5K goes to savings). Assuming we bid on the house and pay full price, I'm thinking about putting $60K down out of our current assets, and the remaining $40K down out of a 401K loan, in order to hit 20% total down. The plan after purchasing the home (which is move in ready), would be to put an additional $1500/month towards the principal of the 401K loan on top of normal payments, until it's paid off (Considering insight provided below, can most likely pay 401K loan off in 1.5 years).

Pro's
*Lock in rates theoretically while they're low now, compared to whatever they''ll be next summer (got pre approved for 4.35% this week)
*Get a home while values are lower in 2014 vs 2015 (they are definitely rising in my area)
*No longer have to continue monthly rent payments of $1600

Con's
*We have to spend $2500/month to break our rental lease
*I risk gains I could be making above 4.25% in my 401K funds while the money is tied up - although I'm not doing much better than this now
*I pay double taxes on the 40K I take out (pay back the loan with money that was already taxed)
*If I lose my job, I have a limited amount of time to pay back the loan

A few other pieces of insight:
*We're in EXTREMELY secure positions right now and income has 90% chance of going up at least 20K by Feb 2015
*Over the past few years, only decent inventory was present from April through beginning of Sep, so consider winter purchases off limits
*We have no debt or other financial obligations
*Additional bonuses will bring in a minimum of $10K by March


All in all, I think the con's are outweighed by the savings that are expected to be experienced due to rate hikes and rising home costs. What do you think?
Topic Author
PlayingLife
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by PlayingLife »

Part of the reason of this post is to bump this as many of you have a better understanding of finance than I do, and I'm interested in your opinion. The second reason is to debate my claim below that by taking a 401K loan, I would be double taxed. Now that I think about it, that's not true, correct? Because I'd be paying the $40,000 with money that is not taxed, when it would normally be taxed already if I wasn't taking out the loan. So when I pay back the loan with after tax funds, I'm essentially paying the taxes already that should have been associated with the money going to the down payment.
alex345
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by alex345 »

You are not double-taxed on the principle of a 401k loan, this has been discussed ad nauseum on the internet. You are double-taxed on the interest. Consider the thought experiment: Day 1, take out a 50k 401k loan. Day 2 take the same 50k and pay it off. You didn't pay any extra taxes, you got 50k and had to put back 50k. Money is money, doesn't matter if it came from your paycheck or from your 401k. Anyways I did a 403b loan for my home purchase, and I felt it was a very good option. With TIAA-CREF they hold 110% of the principle in TIAA Traditional, pay me 3.3% or whatever on that, and I pay 4.15 % to them. The net interest rate is very small.

Of major importance is what happens if your relationship with employer is terminated, do you have to pay it off immediately or risk an unqualified withdrawal?

Edit: One more thing: If you can still max our your tax-deffered space while servicing the 403b loan, then I think most everyone here would say it's a good way to go. If you can't then maybe your are buying too much house. Don't let the loan slow down the tax-deferred accumulation.
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jimb_fromATL
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by jimb_fromATL »

alex345 wrote:You are not double-taxed on the principle of a 401k loan, this has been discussed ad nauseum on the internet. You are double-taxed on the interest.
You're not double-taxed on the interest either. You'd pay tax on the money it took to make payments on a commercial loan, so it makes no difference in your net result. It's no different than having bank stock in a mutual fund in a 401(k). The income tax that the customers pay for the money they pay to the bank on their loans is not relevant to your gain in the 401(k) either.

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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by Twins Fan »

What about buying the home with what you have now and then plowing extra money at the mortgage to get rid of PMI as soon as possible? Seems like you could do that within a year. How much would you pay in PMI in that time would be the question, I guess.

I just don't like 401k loans. That's supposed to be left alone. Just me though.
leonard
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by leonard »

401k is for retirement, not for housing finance.

If you can't afford the house without a 401k loan, you can't afford the house.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.
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Ketawa
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by Ketawa »

Personally I think Bogleheads take too much of a hard line stance against 401k loans. Let's say that a few years ago you decided to save enough for a down payment, and in order to do this you had to cut back on some retirement savings. Most here wouldn't have any objections against this -- only some of us can max our tax-advantaged savings every year.

You weren't planning to buy, so you didn't save outside of the 401k for a down payment. Now your plans change, but your money is locked up in the 401k. 401k loans are just a way to go back in time and change that decision! And you get to keep the tax-advantaged space to boot. In most cases, it's probably easier and cheaper than paying PMI until you reach 80% LTV.

This is what happened to me. I maxed out retirement savings, then moved somewhere I wasn't expecting where I wanted to buy instead of rent. I used a 401k loan to reach a 10% down payment (no PMI with NFCU). My LTV is now about 15% since I prepaid some of the mortgage. I regret that decision; I wish I had prepaid the 401k loan. The improved cash flow benefit is realized sooner and you reduce the risk of it becoming due upon job loss, if that consideration applies.
awval999
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by awval999 »

Well timed post. I'm planning on taking out a 403b loan for our down payment. Of course this is different areas of the country where houses are much less expensive. I plan on only using the bond portion of my 403b to use as a downpayment. Truly, if you keep contributing at the same percentage and only use your bonds (ie: 20% of the total) you really aren't "losing" any future retirement growth. The "interest" that you pay yourself is greater than the bond coupons.
HornedToad
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by HornedToad »

I don't have a problem with your plan assuming:

1. Don't let lifestyle creep slow down your retirement savings/ 401k loan payback
2. You feel that your jobs are very secure and have a plan in case you need to pay back loan on separation
3. Continue to max/nearly max 401k in addition to paying the 401k loan
4. Focus on paying the 401k loan back within 2 or at most 3 years.

We did the above and it worked out very well for us in order to avoid PMI.
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PlayingLife
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by PlayingLife »

Thank you for everyone's responses. I figured there would be a mix of opinions; my whole life I have always followed the rule "pay everything up front, in cash, no borrowing allowed", so I completely understand the statements against a 401K loan. I also don't want to rely on anyone else; our emergency fund and retirement will be building while we're aggressively paying off the potential loan as a safety net in case we lose our very secure jobs. Worst case, I could always borrow from family if I had to. The mortgage will be 37% of our net income (which is high I realize, but we're in a HCOL area and have zero debt and we only have to finance all the typical expenses of a single vehicle), but the odds are in our favor that this will drop to 30% or less quickly after the loan is paid off.

The comment about borrowing the bond portion of a 401K was a unique thought. Anyway, thanks for everyone's opinions. I think we're going to pursue the 401K loan route to own a home this year (gamble on saving in increased housing costs and loan rates vs next year or later) and prevent paying PMI.
leonard
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by leonard »

Oh, I didn't realize it was that kind of "should I take out a 401k loan" question.

In that case, of course.

It really is too bad that there isn't a more affordable house in the area. Anywhere.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.
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hand
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by hand »

Twins Fan wrote:What about buying the home with what you have now and then plowing extra money at the mortgage to get rid of PMI as soon as possible? Seems like you could do that within a year. How much would you pay in PMI in that time would be the question, I guess.

I just don't like 401k loans. That's supposed to be left alone. Just me though.
The devil is in the details with this approach - be aware that removing PMI can be significantly more difficult than paying down the loan to a point where you have 20% equity. In practice, removing PMI often means waiting until 78% LTV according to the original amortization schedule (or refinancing).
wilked
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by wilked »

Fritch, is that 37% calculated as (PITI + 401K Loan)/net income?
Topic Author
PlayingLife
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Re: 1st time home buyer considering 401K loan - Thoughts?

Post by PlayingLife »

Had to dig through my history, find this post, and announce that the 401K loan is paid off! Okay, so it took about 1 year and 8 months instead of 1 year and 5 months, but we never slowed down on retirement contributions (maxed 401k in 2015), and our home's value has increased roughly 20-25K since we purchased. Also, the 5% in interest that I had to pay to myself, is considered healthy growth given my retirement portfolio's return during the same period.

So I have to say that I'm very happy with our decision to originally take the loan. The only con is that I HATE debt, and seeing the $265 out of my bi-weekly pay was getting irritating after a while, and my spouse and I had too many conversations about "paying off the loan". But we were never in any financial hardship and it helped us move in earlier than anticipated, while being able to avoid PMI.

Given my experience, I think a 401K loan is fine if used responsibly. I do admit that most people probably do not use these loans responsibly.
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