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My spouse and I are about to buy our first house, and while we have enough saved up currently for our down payment, we're considering whether it makes sense to use some of that to pay off small student loans and then borrow from our 401k's to make up the down payment. Alternately, is it worth taking out a relatively short-term 401k loan to make part of the down payment (so as to maintain cash on hand for other moving expenses), rather than putting them on credit cards?

Relevant numbers:

  • Combined income:
    • $175k/year (+ quarterly bonuses in the $2500-$5000 range)
    • Net savings of roughly $5000/month (paychecks minus average expenses).
  • Cash-on-hand: ~$25k.
  • Purchase price: $390k, $22k down. (Yes, that's 3% down, non-FHA. The home is cheap for the area, and we have great credit scores.)
  • Retirement savings:
    • ~$36k combined in 401ks
    • ~$8,500 in a Roth IRA
  • Student loans:
    • $3,200 balance, 5.75% interest (variable)
    • $4,500 balance, ~5.75% interest (fixed)
    • Others not worth repaying at this time.

So, we currently have enough on hand to pay the down payment (all closing costs included), and will have at least another $2500 saved up before settlement (payday!). Both 401k's allow for home-purchase loans (I don't know about the Roth), and we have no credit card debit. The difference between what we're paying for rent currently and what we will be paying for the mortgage payment will lower our per-month net savings to (very) roughly $3500.

If we do take money from the 401k's, we'd be planning on paying it back relatively quickly, alongside rebuilding the cash-on-hand savings. As several people have noted in the comments, if we kept saving instead of buying now, we'd be in a position to pay off the loans and not even need to think about borrowing in another six months or a year, presuming house prices don't go up more. But since we are going to be buying now, we're in the position of needing to make that decision.

How should we handle this?

  • You don't mention your rent and mortgage payment. – Brythan Nov 4 '16 at 13:50
  • Is your cah on hand all your savings? or s there also 3-6 months living expenses saved as an emergency fund? what does "others not worth repaying at this time" mean? – mhoran_psprep Nov 4 '16 at 13:52
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    Loans from 401k are never as good a deal as they initially appear. Consider them a lender of last resort. – keshlam Nov 4 '16 at 16:25
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    One problem with 401(k) loans is that they become due if you leave the job. That can turn a layoff into a real problem. – zeta-band Nov 4 '16 at 16:52
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    Why not just use your net savings for the next 2 months to payoff the student loans? – Wesley Marshall Nov 4 '16 at 20:18
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You say

Net savings of roughly $5000/month (paychecks minus average expenses).

However you list

  • Cash-on-hand: ~$25k.
  • ~$36k combined in 401ks
  • ~$8,500 in a Roth IRA
  • $3,200 balance, 5.75% interest (variable)
  • $4,500 balance, ~5.75% interest (fixed)
  • Others not worth repaying at this time.

So your net savings, including retirement, are only one year's excess income and are well under six months income (about four months). At best, your cash on hand is only two to three months of expenses. Using an income standard, it's not even two months.

In a comment you note

The mortgage payment will be about $1100 more than rent is, plus picking up a few more utilities we currently don't pay for.

I'm not sure whether the $5000 includes that $1100 or not, but even if we assume that it doesn't (that you already adjusted your expenses up by $1100 a month), you are way short of recommended savings. And that's just looking at your $175,000 of income and ignoring bonuses.

Given your income, you'd be safer waiting until you had a 20% downpayment, but it sounds like that ship has sailed. I wouldn't borrow from retirement accounts without some genuine emergency, which a house purchase is not. It wouldn't be enough to get rid of your private mortgage insurance (PMI) payment and the interest rate is probably worse than that of the mortgage anyway.

By the six months expenses standard, you should have at least $57,500 in emergency savings. You currently have $25k and expect that to drop to $5k when you buy the house. I prefer a sixth month income standard, which would be more like $90k or $100k.

You have two relatively high rate loans. Given your income, it's unclear why.

In twelve months, you could pay off those loans and establish a reasonable emergency fund. Except that leaves nothing for retirement. If you want to maintain income after retirement, you should be maxing out your retirement savings. That's around $47k a year ($18k 401k and $5500 IRA for each of you).

I'm guessing that you are relatively young and are both shortly out of college. You look at numbers like $70k savings and think of it as a lot. But it really isn't. You are spending $115k ($175k minus $5k per month) or more. $70k is only seven months of expenses. You couldn't retire on that.

It is early for you to be buying a house. If one of you has a work setback, you could have a lot of trouble with that house. Your savings aren't sufficient to pay your expenses for six months. You are going into a hole to increase your monthly expenses. This is essentially the problem that people had in 2007. They bought overvalued houses, encountered a setback, couldn't sell the houses and move because prices had fallen, and couldn't keep up the mortgage.

While emergency savings should be a major focus, I think that I would start by getting rid of the two loans. It's only two months. And don't take out any more unless you have an actual emergency. No balances on credit cards (amounts paid off in the grace period are fine).

Max out your retirement. At your income, you won't be able to contribute as much as you want to the tax advantaged accounts. So don't waste that contribution space.

Put the rest to emergency savings until you have at least $60k. After that, start putting the rest into equity in the house. Build up your equity to 20% and get rid of the PMI. At that point, I'd recommend getting your emergency savings up to $100k, although others disagree.

Once your emergency savings and 20% equity are secured, go see a financial planner, pay a fee, and work out how much you need for retirement. You are probably going to have to put savings in regular accounts to afford retirement. Your expenses are extremely high. If you want to maintain that lifestyle in retirement (and you likely will be used to it by then), you'll need more savings than the government encourages.

You also might consider how kids would affect things.

  • For what it's worth, we're already maxing out our retirement accounts, HSA, and are working on paying off those last two loans. As you noted, we could easily pay them off in a few more months, and that was the original plan. As for the rest of this, thank you. We'll go discuss this (and any other answers that come in). – UnlinkedAccount Nov 4 '16 at 16:50
  • @UnlinkedAccount I think what you're missing from Brythan's response is that building financial security has to start from the top priority, even if that means not being able to take full advantage of better returns in the long term. In other words, there is no point in saving for the future 30 years from now if you are unprepared for a catastrophe tomorrow. You need to cover your basic and short-term needs first. Then cover your future retirement needs. Then look into real estate. In this order, your question becomes moot. – heropup Nov 4 '16 at 18:14
  • My perspective: Brythan has a valid and very conservative fiscal outlook, but not one that maximizes your wealth. Putting large amounts of money (in excess of $50K) in savings that earns almost nothing while at the same time maintaining debt will reduce your total wealth significantly over time. If you should lose your jobs and your savings doesn't get you by before you get a new job, you can borrow. For that reason, it makes sense to have moderate emergency savings and pay down your debt aggressively. – farnsy Nov 4 '16 at 22:03
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I'm going to assume you positively are going to buy this house right now and have no interest in paying down your student loans or saving first.

Given that, should you

  • Borrow from your 401(k) to pay off your student loans
  • Borrow from your 401(k) to add to your down payment
  • Borrow from your 401(k) in order to have cash on hand during your move

If there were no risk or inconvenience considerations, then borrowing from your 401(k) to pay down debt (whether student or mortgage) makes technical sense as long as the debt you pay down has a higher interest rate than what you expect to make in your 401(k). Future 401(k) earnings are hard to predict, but don't exceed 5.75% on a risk adjusted basis. (In other words, if you could choose whether to get 5.75% risk free or whatever the market will give you, the 5.75% is a much better investment). The same situation may also hold for your mortgage rate, especially when the effect of PMI is included.

A couple of things to remember:

  1. In some plans you can't continue making 401(k) contributions while you have a loan outstanding. This may not matter to you since you plan to pay it back quickly. Make double and triple sure you won't miss out on any employer matching.
  2. If you lose your job, you have to repay your 401(k) within 60 days or something normally.

OK, having said all that and being clear that you are only talking about a short-term loan and not a way of life nor a change in lifestyle that will tempt you to not pay back your loan, it's probably fine to borrow from your 401(k) for any of the three reasons mentioned above. You definitely don't want to pay credit card interest and there's no reason to be dragging your student debt around at that rate. Pay that stuff off and then put all your money toward quickly repaying your 401(k) loan, then your mortgage.

The lowest rate you have is your mortgage rate, so I'd hesitate to increase your down payment out of 401(k) funds. It's up to you, though. Mortgage insurance is a cost you would like to get out of as quickly as possible.

Also, be aware that once you buy a house, you will start wanting to buy lots and lots of things to put into the house--happens to everyone. Restricting yourself to the budget you kept while in an apartment will be near impossible. To me it seems like you have decent slack in your budget, but just remember not to plan for best-case scenarios. Plan for reality.

  • Future 401(k) earnings are a safe bet to be less than 5.75%? Since the last 100 years have averaged over 9%, closer to 10%, are you saying "this time is different"? If a 401(k) loan were able to negate the need for PMI, the story might change, i.e. It might make good sense. But here, the downpayment is too low. – JoeTaxpayer Nov 5 '16 at 18:04
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    I should rephrase that. 401(k) earnings certainly may exceed 5.75%, but a certain 5.75% far exceeds 401(k) earnings on a risk adjusted basis. 401(k) earnings can be and often are negative. Consider that the logic of your objection suggests that borrowing at 5.75% (a margin loan) in order to fund long-term equity investment would be a good idea. Do you feel this is the case? – farnsy Nov 5 '16 at 18:35
  • Consider, the return for the 15 years from 2000 to 2014, which included the awful 00's decade, returned a compound 4.2%/yr overall. This beats the OPs 3.5% rate, and begs the question of how disciplined he'd be. BTW, I upvoted this answer. Logical, well written. – JoeTaxpayer Nov 5 '16 at 18:44
  • I am sorry, I don't see where the OP mentions a 3.5% rate, but if it is that low, then you may be right. The OP should also consider that PMI goes away once you hit 22% even if your down payment doesn't reach this amount. So a larger down payment means you will pay less PMI over time, right? – farnsy Nov 5 '16 at 18:49
  • Sorry, the other mortgage question said 3.5%, not this one. But that's the present US 30 year rate, so probably close. Not all PMI goes away at 78% LTV. I agree, most do. But your other points 1 and 2 shouldn't be ignored. Question still missing the details we should have, such as whether 401(k) is matched, and how much, as well as details to your point 1. – JoeTaxpayer Nov 5 '16 at 19:26
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You're neglecting risk when you consider borrowing from the 401k. What happens if the borrower loses their job?

I looked it up. According to the TurboTax FAQ, you have two months from the date of termination to repay the entire 401k loan. If you fail to repay, then any loan balance is considered a withdrawl, and you'll have to pay regular income taxes plus a 10% penalty on the balance. If there's a 401k loan balance when you leave your job.

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