Today I want to discuss an additional source of money for a down payment on a house that people often do not think of: your 401k.
Taking money out of your 401k is one of the major “sins” of personal finance; you just don’t do it. Your 401k is meant to be spent in retirement and not a day before. What most people don’t realize, though, is that some companies allow you to borrow a certain percentage of your 401k balance. Where I work it’s 50%, other companies may have different policies.
You might still be thinking “well that sounds good but how is this any different than taking money out of your 401k?” Let’s look at the facts:
1) You aren’t withdrawing from your 401k; you are borrowing against the asset that is your 401k
When you take a loan against your 401k, the major drawback is the balance you borrow will not be exposed to the market while it’s in repayment. You are NOT withdrawing the balance. Instead it is a structured loan where you are paying yourself (or your 401k if it is easier to think of it that way) the balance you borrowed plus interest. Yes, the interest on the loan is paid essentially to yourself. The loan payment is automatically deducted from each paycheck, and can be very low relative to the amount you are borrowing (think $100/month for a $5,000 loan).
2) The fees you pay are very low
The plan through my employer has very few fees. Essentially all you need to pay is a one-time fee of $50 to set up the loan, plus a $2.50 quarterly maintenance fee. That’s it.
3) Think of it as shifting investments
Especially if you are currently renting, buying a home now could be a great long-term investment. The fact is home prices are very low and interest rates are relatively low. These two market conditions will not stay like this forever; prices will increase, and rates will most definitely increase in the near future. Two more variables to bring into the equation: you need a place to live, and if you are not living at home with the rents or already a home owner, you are paying rent. Buying a house now takes advantage of the low home prices, the low interest rates, and allows you to build equity instead of writing a check to a landlord each month.
4) There is a catch…
Besides not having the balance you borrowed exposed to the stock market, there is one other drawback. If you get layed off, fired, or leave your employer for any reason, you have 60 days to pay back the remaining balance of your loan. If you take out a $5,000 loan today and next month leave your employer, you WILL owe more than $4k, and you will only have 60 days to find the money. If you don’t, you will get hit with the same penalties as you would if you withdrew the balance out of your 401k. Don’t let this happen to you. Make a reasonable decision of how much you will borrow, because you very well could find yourself in this situation.
With all that in mind…
Don’t let someone talk you out of borrowing against your 401k because it should be “only touched in retirement.” You will (or should) put every dollar back that you take out. Look into whether borrowing against your 401k is an option for you, what the exact terms are, and consider asking a financial adviser if this move makes sense for you.
Have you ever borrowed against your 401k? Does your company allow it?
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Photo by Diana Parkhouse
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