In this day’s real estate economy, buying a house can draw pretty heavily on your income. When you look at it on the other hand, in this day’s real estate economy it could be a great idea since land prices and real estate prices in general are lower than they normally are. When it comes time for you to make your mortgage down payment, you have several options available to you: use your cash and/or saved income, cash in investments, take out a larger loan to take care of the down payment, or take out a loan against equity you already have.
In this article we will be focusing on the very last option, taking a loan out against equity you already have and, more specifically, taking a down payment loan out against your 401k. For this method of home buying to work, however, you have to meet a few criteria; this still doesn’t mean that it is the right choice for you though.
If you have a job to where you invest money into a 401k from every paycheck, then you are on the right start. Many 401k’s these days will allow you to pull money that you have already invested into it in the form of a loan; most 401k plans will let you take a loan out for about half your balance. This way if you default on your loan, then the bank can take the rest leaving you with no debt… and no retirement either.
The how to on this matter is very simple. In the age of internet guided investing, most 401k can be controlled via a website or through a telephone operator working for the investment firm. Many companies, such as Fidelity, will let you take out a loan against your 401k (this particular firm will allow you to take loans in excess of 50%) without ever speaking to a person at all. You just select the option and amount on a self guided website, and the check is mailed to you. You don’t have to specify a reason for all of the investors, although some do require you to, and you can do with the money what you wish.
We’ve determined that you can take a loan out against your 401k, but there is still a very important question looming: should you? To answer this question in it’s entirety, you have to look at not only the monetary side of the equation, but the economic side as well.
For an example, let’s say you have $16,000 tucked nicely away in a 401k. If your investment firm lets you take a loan out against 50% that would be an $8,000 down payment on a home; a good chunk of a 10% down payment on a $100,000 mortgage. At a very conservative 7% compound interest rate, in 30 years your $8,000 would be $120,000. If you take a loan for half out, you will be significantly below the $60,000 you would expect. The wonders of compound interest are indeed infinite. Looking at this from a logical standpoint, not only do you have to remake the $8,000 you took out, but you have to remake the interest you lost while repaying it; you also have lost the opportunity cost to create even more interest from the money you would have been accruing had you not been repaying the loan.
All this said and done, this article isn’t saying a simple matter of fact that you should not go down this route, All I am trying to tell you is that this is an extremely weighty decision that requires a lot of thought. If the housing market is so low that the value made on your house outweighs all the opportunity cost on losing equity in your 401k, then now might be the right time for you to do this.
