I’m buying a condo and most of my money is tied up in retirement accounts. To come up with a 20% down payment, I’m considering doing a 401k loan (will also roll a traditional IRA into my 401k to borrow against). Here are the pros and cons as I see them:
Pros:
Borrow money from yourself instead of the bank.
Preserve tax advantaged status of 401k/IRA money.
Pay yourself interest.
Cons:
Can create cash flow problem
Can’t prepay small portions of 401k loan, it’s all or none.
If employment is terminated, full balance is due back immediately, so will need to maintain a large balance of low risk investments to offset.
Thoughts?
401k Loan for Condo Down Payment
Re: 401k Loan for Condo Down Payment
How quickly could you repay the loan?
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EdithKeeler
- Posts: 1099
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Re: 401k Loan for Condo Down Payment
I’ve used 401k loans twice to buy houses. I was able to make extra payments, however, to payoff early. Worked out fine for me. I have a really stable job and no concerns about layoffs, etc.
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suomalainen
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Re: 401k Loan for Condo Down Payment
I used a 401k loan to refi my second mortgage (nobody throw eggs, I was young). My thoughts:
1) Make sure you can afford it. Presumably you will need a conventional mortgage for the balance and you'll need to account for the 401k repayment from your paycheck to apply and qualify for that loan. Sounds like you're already aware of the cash flow implications tho.
2) People say "but you're taking pre-tax money and paying it back with post-tax money". Yes. But you also get to use that pre-tax money, you don't just burn it. More of a valid point if you're buying stupid shit with it.
3) If your 401k is invested in stocks, getting a 401k loan is a bit like shorting the market, so I suppose consider your views of the future of the market or something. The way this is typically expressed is "But you'll miss out on market gains!!!" True. But only if the market gains.
4) If you have the ability to pay it off quickly if you're fired or want to change jobs, then it's ok; if not, you're creating a problem for yourself down the road (10% tax penalty plus back taxes, iirc).
So, in my case I did it because I was confident I wouldn't get fired in the 5 years of the term and I wanted to short the market. Didn't work out so well on that second point, but at the same time I was paying off an 8.25% second mortgage, so I'll take a guaranteed 8.25% return any day of the week.
1) Make sure you can afford it. Presumably you will need a conventional mortgage for the balance and you'll need to account for the 401k repayment from your paycheck to apply and qualify for that loan. Sounds like you're already aware of the cash flow implications tho.
2) People say "but you're taking pre-tax money and paying it back with post-tax money". Yes. But you also get to use that pre-tax money, you don't just burn it. More of a valid point if you're buying stupid shit with it.
3) If your 401k is invested in stocks, getting a 401k loan is a bit like shorting the market, so I suppose consider your views of the future of the market or something. The way this is typically expressed is "But you'll miss out on market gains!!!" True. But only if the market gains.
4) If you have the ability to pay it off quickly if you're fired or want to change jobs, then it's ok; if not, you're creating a problem for yourself down the road (10% tax penalty plus back taxes, iirc).
So, in my case I did it because I was confident I wouldn't get fired in the 5 years of the term and I wanted to short the market. Didn't work out so well on that second point, but at the same time I was paying off an 8.25% second mortgage, so I'll take a guaranteed 8.25% return any day of the week.
Re: 401k Loan for Condo Down Payment
Thanks!
The interest rate I'm paying my self is 5.75%, and I picked the max term available, 180 months. 180 months is a huge amount of time, but I don't want to create a cash flow problem. I can easily cover $134 a paycheck, and take what I have leftover to put in a bond fund to start offsetting the liability.
~1/3 of the loan is roth 401k money, so I'll be paying myself with post tax money and upping that balance, but the other 2/3 is traditional 401k, so paying myself with post tax money to pay taxes on it when I reach traditional retirement age. But tax free growth.
The interest rate I'm paying my self is 5.75%, and I picked the max term available, 180 months. 180 months is a huge amount of time, but I don't want to create a cash flow problem. I can easily cover $134 a paycheck, and take what I have leftover to put in a bond fund to start offsetting the liability.
~1/3 of the loan is roth 401k money, so I'll be paying myself with post tax money and upping that balance, but the other 2/3 is traditional 401k, so paying myself with post tax money to pay taxes on it when I reach traditional retirement age. But tax free growth.
Re: 401k Loan for Condo Down Payment
It's worth considering for sure. I'm effectively trading one overpriced asset (stocks) for another (real estate) with a bunch of leverage added.
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Mister Imperceptible
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Re: 401k Loan for Condo Down Payment
It’s particular to your situation. How much money are you “throwing away in rent” compared to the equity you could be building in an owned condo, and IF this would remain a positive exchange even IF the housing market declined. WHAT market you live in locally— is it overpriced? If the housing market declines, so be it. You are not obligated to sell at that time. Even if you move, you would perhaps have the option of renting it out?
The missing question here is, are you living in this condo and would be renting otherwise, or is this a income property?
If you are obligated to keep safe investments to be able to cover the loan, that’s not a bad thing, as some portfolio theorists would advise you to have a healthy cash reserve anyway. This would also be a measure of safety to take opposite the risk you are taking by levering up.
If you do take out the loan, it’s as @Suo says, you are shorting the stock market, which IF valuations are high as @Augustus says but the equity gained/money thrown away on rent ratio is favorable, equity gained could be the tiebreaker because you are long one of two overpriced assets either way which becomes a wash. I might do that in a LCOL area.
**BUT** if you are in an overpriced market the size of the asset purchased could weigh too heavily because of leverage used.
The missing question here is, are you living in this condo and would be renting otherwise, or is this a income property?
If you are obligated to keep safe investments to be able to cover the loan, that’s not a bad thing, as some portfolio theorists would advise you to have a healthy cash reserve anyway. This would also be a measure of safety to take opposite the risk you are taking by levering up.
If you do take out the loan, it’s as @Suo says, you are shorting the stock market, which IF valuations are high as @Augustus says but the equity gained/money thrown away on rent ratio is favorable, equity gained could be the tiebreaker because you are long one of two overpriced assets either way which becomes a wash. I might do that in a LCOL area.
**BUT** if you are in an overpriced market the size of the asset purchased could weigh too heavily because of leverage used.