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Does it ever make sense to cash out my 401k in order to make a larger house down-payment?

Say I have a marginal tax rate of 35%. If the difference between the interest in the 401k and the mortgate rate is (for example) -2%, then over a 20 year mortgage I would expect to avoid paying roughly 40% of that value in interest. But at the same time I incur a 35% tax on the money.

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    Maybe in the scenario where you don't expect to live until retirement age. What do you expect to do in retirement without retirement savings? – JohnFx Dec 17 '15 at 4:17
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Does it ever make sense? Yes, but almost never.

If you're in a situation where you're invested in something with low rates (think government securities) or cash equivalents, then you do need to think about rate spread as you mention. Does the savings over the life over the mortgage beat out the 35% hit now, plus all the interest you would earn over those 20 years? Have you factored in other considerations such as mortgage interest deduction on taxes? Don't forget you need to think about how rates will change down the line (they can't go much lower, so potentially you'll get better rates in the 401(k) down the line). Don't forget there's also the impact of inflation; again the rates on your savings may go up, but your mortgage is a fixed payment, so with even a low rate of inflation, your payments effectively become "less" over time.

If your investments are in something like stocks and bonds, then I would say undoubtedly you would want to keep the money in the 401(k). Time in market and compounding are your best friends over a long time horizon.

Also, as mentioned by @JohnFX, the hit of your 35% now is something you will absolutely feel now. Hopefully not, but your life situation could change where you have an emergency and need to drain your savings or you may not see the end of that 20 years.

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As @AlexKuhl says, ever? yes, but generally? no.

If your 401k is invested in stocks and bonds, the long term return is very likely higher than the interest on a mortgage. Long term return on the stock market is around 7%. Mortgage rates these days are around 4%. Add the tax penalty on top of that and you're almost surely better to keep your money in the 401k.

There's also the psychological/budgeting factor. People very often say, "I'll pull money out of my retirement fund for this important purchase and then put it back later." And then later comes and there are other expenses and things they want to do and they never put the money back.

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Absolutely never.Even in a hot market, it's like picking up dimes in front of a bulldozer. It's just plain stupid. If you can't afford a 20% down payment and a 15 year mortgage, just rent.

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