Mortgage vs 401k Loan

Related Articles

Buying a Foreclosure

Mortgage? Or 401k Loan?

We want to buy the foreclosed property next to us. Although it will stretch us, we really don't want to let it get away. We are approved for $30,000 with 30% down at 7.25% with a local bank. The $9,000 down will come from our $40,0000 retirement fund. Or should we borrow the whole amount from our retirement fund at Vanguard? I'm hoping to get the property for $25,000 plus $3,000 or less in closing costs. Which would I be better off doing in your opinion?
Michelle in Northern Michigan

Don't Take on the Financial Burden

Two things in your note trouble me. First, you say that making payments on this property will stretch your finances. Then you say the only way you can make the down payment is to borrow from a retirement account. I see these two statements as red flags. You cannot afford to buy this property.

Please re-consider taking on this financial burden. I'm sure your intentions are good, but if your finances will already be stretched making the loan payments, you're likely to fall behind on the retirement account re-payments. Defaulting on your re-payments will not only lead to tax and penalty consequences both with the IRS and the state of Michigan, but it will also eat into your retirement security.

My suggestion is to buy the property only if you can come up with the down payment without tapping into your retirement accounts and if you can afford to make the monthly loan payments comfortably.

What If You Lose Your Employment?

This inquiry raised multiple red flags to me. The statements "although it will stretch us" and "we really don't want to let it get away" are the makings of a bad proposition. You don't need the property but want it and apparently don't have the funds to buy it or an emergency fund from which to draw it. Being stretched to make this deal happen could put you in a very precarious financial position. Add to this the fact that you are considering "borrowing" from your retirement fund. While it may be possible to borrow from your retirement, that doesn't make it a great idea. You will be borrowing untaxed money (that you contributed) and paying it back with after-tax money plus an interest rate, making it very expensive to the tune of 18% interest or so.

Because you say that you are borrowing from your retirement plan, I'm assuming you are still employed and have the intention of paying back the loan. If you should lose your employment while the loan is outstanding, you have only 60 days to repay the balance in full or it will be considered an early withdrawal and you will pay a 10% penalty if you are under age 59 1/2. You will also pay taxes on this amount and it possibly could throw you into a higher income tax bracket when added to your other income. If you really think that buying the property ultimately is a good deal, possibly a more economical way to go about this is to borrow against the equity in your current home at a reasonable interest rate. If you are able to itemize, the interest you pay on this loan could be tax-deductible. It's called a retirement plan for a reason! Good luck with your decision.

Think Twice

I urge you to think twice about buying the property. You admit that affording it will be a stretch. What will happen if you lose your job(s)? How will you pay the mortgage? A lot of people have gotten in trouble by taking on more house debt than they can manage. That's partly what the subprime crisis is about.

Do you have an emergency fund with sufficient money for three to six months' expenses? If you plan to borrow the down payment from a retirement fund, I suspect you may not have much cash set aside in a savings account for emergencies or for investing such as this. And, by buying the house, you are investing.

Are you planning to quickly "flip" the house and make money that way, figuring you won't have the mortgage for very long? Again, I urge you to think about this very, very carefully. The housing market is not robust, and if the foreclosed house next door to you hasn't sold by now, maybe there's a reason.

I know this isn't the answer you wanted, but as someone on the verge of sixty who has weathered some pretty tough financial storms, I had to say what I just said. Investments in real estate must take a back seat to having enough money in case of job loss and even to retirement.

At any rate, as to mortgage or 401K, if you borrow from the 401K account, you will lose any money you might have made if the money were invested. And you will have to pay the money back, or pay taxes on the amount if you don't. Again, look hard at your financial situation before you do something you might regret.
S Nelson

Look Beyond Right Now

"Although it will stretch us, we really don't want to let it get away." This is the biggest problem in our country right now. Many are putting what they want now ahead of what they'll need and want later (retirement with dignity). Purchasing this property is not only going to "stretch" you now, but also you are putting future retirement at risk. Why not take what you'd spend on a mortgage for this property and save that amount in a mutual fund, and in a few years, you'd be able to pay cash for a similar property? If you choose to borrow from your retirement fund, you will be losing years or decades of compounding interest that can never be regained, not to mention taxes and fees that may occur for withdrawal of funds. In cases like this, time is very unforgiving.

If you chose to finance with a mortgage, you say that you will be stretched. This tells me you need to take care of what you have going on now (financially). Then when you get your financial house in order, you can look at foreclosures again. This is not the only foreclosure that will come up; in today's society, there will definitely be more in the future. I know this may go against what others will say, but it just doesn't seem financially sound to me.

Take the Next Step:

  • Make sure you're not overpaying on your mortgage. If you haven't looked for a lower mortgage rate in the past year, use our simple tool that compares different lenders to see what your monthly mortgage payment could be. It's private, only takes a minute and could show you how to save thousands!

Share your thoughts about this article with the editor: Click Here

Stay Connected with TDS

Little Luxuries

to the Dollar Stretcher newsletter and get a copy
of our ebook
Little Luxuries:
130 Ways to Live Better...For Less
for FREE!

Your Email:

View the TDS Privacy Policy.

Debt Book