It might be tempting to borrow from your 401(k) to buy a house, but experts say it's almost always a bad move you'll regret
- If you're planning to buy a house, you'll be asked to make a substantial down payment.
- However, you'd be wise not to take that down payment from your retirement savings. In most cases, experts advise leaving your retirement savings for their intended purpose: retirement.
- If you take your retirement savings out early, you'll not only pay taxes and fees on the withdrawal, but you'll miss out on future gains ... and you might not have the cash to pay back your "loan."
- SmartAsset's free tool can find a financial planner to help you meet all your savings goals »
Retirement savings are for the future, for a day when you're no longer working and need a source of income to pay the bills.
In fact, experts say borrowing money from your retirement savings is generally a bad idea. In most cases, borrowing money from long-term investments, like your 401(k), has more drawbacks than benefits.
Here's why it's not a good idea to take out a 401(k) loan for your down payment:
1. You might miss out on appreciation
One of the main drawbacks with borrowing from your retirement fund is that you could be missing out on making money for your future. Florida-based financial planner Brian Pirri says when you take money out of an account that's meant to grow over time, you're essentially taking yourself out of the market - which means you could lose out on substantial appreciation during a market upswing.
2. You might not be able to afford to pay it back
Another reason not to withdraw early from your 401(k) to fund a home purchase? You may not have the money to pay it back when you need to, Pirri says. Most 401(k) loans are shorter in nature - usually, you will need to pay them back within five years. It's important to remember that when you buy a house, you'll have numerous other monthly expenses, which could impact your ability to pay back the 401(k).
3. You may face a tax penalty
It may sound appealing to dip into money you've already saved, but you'll probably end up paying more for it later. For example, if you're not of age to tap your retirement account, you'll have to pay taxes on the amount you took out. Pirri says you will also face a tax penalty for withdrawing from your retirement savings early. "The government doesn't want people taking funds out early, and they will hit you with a 10% fee for doing so," he says.
4. You may not get approved for your mortgage
Since you're basically borrowing money from your 401(k), underwriters view 401(k) loans like they would any other kind of debt, Pirri says. If a 401(k) withdrawal results in a higher debt-to-income ratio, you may not get approved for the same amount you would have without withdrawing.
How to save for a home without draining your retirement accounts
If you're in the market to buy a home but you're struggling to come up with the money you need for a down payment, it may be wiser to put your home search on pause until you can save enough money to lower the risk of the purchase.
Want to boost your savings without borrowing from other investments? Pirri has a few suggestions for simple lifestyle changes that can make a big difference:
Pay yourself first
Saving becomes a lot easier when you're motivated. Rather than a sacrifice, think of saving money as paying yourself - it's an investment in your future.
If possible, Pirri recommends having your HR department split up your paycheck and depositing a set amount every pay period into an account you have dedicated to your house purchase. By keeping those funds segregated (and preventing them from ever touching your checking account!), you will be less likely to dip into them.
Pay off your credit cards
Making an effort to pay off credit card debt is a great way to prepare for home-buying, Pirri says. Not only will you have a hard time saving money for a down payment if you're losing up to 18% on interest annually to credit card companies; you'll also have a lower approval amount if you have a higher income-to-debt ratio.
By playing the long game and strengthening your finances now, you'll be far more likely to buy the house you really want - and be able to pay for it - later.
Make little cuts in your budget
Finally, every purchase you make is money you could have saved for a down payment. If you can't come up with a large sum, start small, and appreciate that small things add up.
Skipping your daily coffee purchase is cliched personal finance advice for a reason - it can give a real jolt to your savings. "If you buy a cup of coffee on the way to the office every morning for $3 that adds up to $15 a week, $60 a month, or $756 a year (in round numbers)," Pirri says. "Brew your own at home and pocket the difference!"
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