Home prices are creeping up. So are mortgage interest rates. You’re thinking it’s now or never when it comes to buying house. But where are you going to come up with the down payment?
The days of $0 down mortgages are over, so buying a house means coming to the party with a hefty chunk of change. But not many people have a lot of cash on hand.
The average savings account balance in the U.S. is less than $6,000, according to a report by Pitney Bowes, a document-management services company. Nearly half of Americans struggle to come up with $2,000 in 30 days, according to a study by the National Bureau of Economic Research.
The biggest asset for many people is their 401-K, the retirement savings plan they’ve been feeding during their working lives.
There are a couple of ways to break that retirement piggy bank — take a loan or take an early withdrawal.
A straight withdrawal is plain stupid. You will lose 30 percent or more of the money to federal and state income taxes. There is also a 10 percent federal penalty.
Tax law does allow first-time home buyers to draw up to $10,000 from a traditional IRA account without a 10 percent penalty — if the money used for a home purchase within 120 days.
Depending on your company’s plan, you may borrow up to half of your 401-K balance, up to a maximum of $50,000. You must pay the account back — with interest. Repayment is typically over five years. Some companies may allow the loan to be repaid over 15 years.
“Generally, it is not a good idea to withdraw or borrow money from your 401-K,” says Sean Ciemiewicz, principal of Retirement Benefits Group in San Diego. “You should try to keep the money in the plan as long as possible for growth and your future.”
There are substantial costs to borrowing from your retirement account — in addition to the monthly payments. Retirement savings are lost when you borrow from a retirement plan because:
- You lose potential growth on the earnings, or compounding of those earnings.
- You repay the loan with after-tax dollars.
- There may be an initial set-up and quarterly loan fee.
- Many people decrease 401-K contributions to compensate for the loan payment.
- You may not be paying yourself back at 5 percent when market returns are 10 percent.
The Principal Financial Group has crunched the numbers and figured that borrowing $5,000 from your 401-K at age 35 reduces the value of your retirement account at 65 by more than $52,000.
“There tend to be more cons than pros,” says Ciemiewicz.
There may a few circumstances in which tapping your 401-K makes sense, says James Poe, founder of Texas Retirement Specialists.
“If you have a chance to buy a home that recently went through foreclosure, and you don't otherwise have access to the cash to buy the home, this is probably a great idea,” says Poe, who has a Master's Degree in Financial Services.
“If the home is in good condition, if you can make the installment payments to repay the 401-K loan and the new mortgage, and this will allow you to get a great deal on your first home, I would jump on it. There aren't many reasons that I would support for taking a 401-K loan, but this one passes muster.”
But you also need to ask yourself — if I have to raid my retirement plan, do I really need to buy a house?