Debt Free Saving For New Home

[Heisman210]

Hello all. I am very blessed to be in the situation I am today. I just sold an investment house, and the proceeds are enough to take care of all debt in my family's life. Now my wife, mother-in-law, grandmother-in-law, and I will be moving into my grandparents home rent free since they passed a few months ago.

My wife's income, and her grandmother's social security will be enough to support the 4 of us. Leaving my salary of roughly net $4000/month to save for a new home of our own. I was wanting some advice on what to do with that income to maximize it's growth during the time we stay at this home. Would like it to only be a year, 2 tops.

So what is the best route? Try to find a high interest savings account? 2 year CD? Just leave it in my checking? Dump it all in my 401k and borrow from it when time comes to use as down payment for home? Have done that in past for smaller purchases, and have had checks garnished to pay it back. Any advice is greatly appreciated.

[Jluke]

You could do an online account like Ally or CapOne where you get approximately 1.75%. 10k minimum at CapOne.

You could try CDs. CapOne has a 12 month at 2.4% right now.

Just two examples.

[disneysteve]

Dump it all in my 401k and borrow from it when time comes to use as down payment for home?

Absolutely not. Your 401k is a RETIREMENT account, not a personal ATM to draw from when you need cash.

With a 2-year time line, you need to look at online savings or CDs, as Jluke mentioned.

[Nutria]

Every month for the next 12 months, open a 12 month CD at an online bank like Ally, Barclays, Capital One, Synchrony, etc with your $4,000 net income. At maturity, don't let them roll over; send the money to a savings account at that same bank. Staring the 13th month, put the $4K/mo into that same savings account.

Afte 24 months, the final CD will mature and you'll have maximized your returns while eliminating risk that you'll lose a big chunk in the stock market. (You'll be using this money in two years, not twenty!!)

Changing subjects: what about your Emergency Fund, and "known future expenses" like car maintenance fund (tires, etc), medical deductible, etc?

[Heisman210]

Every month for the next 12 months, open a 12 month CD at an online bank like Ally, Barclays, Capital One, Synchrony, etc with your $4,000 net income. At maturity, don't let them roll over; send the money to a savings account at that same bank. Staring the 13th month, put the $4K/mo into that same savings account.

Afte 24 months, the final CD will mature and you'll have maximized your returns while eliminating risk that you'll lose a big chunk in the stock market. (You'll be using this money in two years, not twenty!!)

Changing subjects: what about your Emergency Fund, and "known future expenses" like car maintenance fund (tires, etc), medical deductible, etc?

Already have separate accounts that direct deposit from check. 2 $100 per paycheck, 1 $200, and the rest is dumped into a general checking. The others are my rainy day funds. Try to keep them at $1k min each. Currently they are where I need them to be. So the excess can be added into the monthly CD purchases/savings deposits.

The plan sounds great thank you for the advice!

[TexasHusker]

I actually like the borrow-from-the-401K idea if your employer is matching.

Let's say you need $30,000 for a home down payment.

Let's also assume that your employer is matching your 401K contribution up to 50%.

So in two years, if you put in $20,000, and your employer puts in $10,000, you've got your $30K, and you just borrow that and pay yourself back at whatever interest rate you choose.

Your employer is effectively paying one third of your down payment.

If you just sock your own $20K away, no one is matching that, and you've got another $10K to go.

I would get my employer to pitch in.

Not much I would borrow against a 401K for, but buying real estate or starting a business are two reasons that I would, and in fact I did.

I funded half of my first franchise with $50K from a 401K loan. That business has been producing $50-70K a year profit since 2012. I think that may have been a wise decision.

[Nutria]

https://money.cnn.com/2017/08/14/retirement/401k-loan/index.html

4. Taxes and fees will cost you
When you repay the money from a 401(k) loan, you do so with after-tax dollars (rather than with pre-tax money, like with your individual contributions). When you take the money out of your retirement account as a senior, you're taxed because no distinction is made between the pre-tax contributions you made to the account and the after-tax loan repayments. You're forced to pay taxes twice: once when the money went in and once when it come out -- which can cost you thousands.

To make matters worse, interest on a 401(k) loan isn't tax deductible, so if you're borrowing money toward a house or if you've taken cash out of a 401(k) to repay student loans, you're not even getting a mortgage interest deduction or taking advantage of the tax deduction for student loan interest that you would likely otherwise be entitled to take.

You'll also have to pay fees, in most cases, to take a 401(k) loan. These fees can be higher than the costs associated with a conventional loan.

[bjl584]

I actually like the borrow-from-the-401K idea if your employer is matching.

Let's say you need $30,000 for a home down payment.

Let's also assume that your employer is matching your 401K contribution up to 50%.

So in two years, if you put in $20,000, and your employer puts in $10,000, you've got your $30K, and you just borrow that and pay yourself back at whatever interest rate you choose.

Your employer is effectively paying one third of your down payment.

If you just sock your own $20K away, no one is matching that, and you've got another $10K to go.

I would get my employer to pitch in.

Not much I would borrow against a 401K for, but buying real estate or starting a business are two reasons that I would, and in fact I did.

I funded half of my first franchise with $50K from a 401K loan. That business has been producing $50-70K a year profit since 2012. I think that may have been a wise decision.

Of course, you are talking about income producing assets. OP is talking about a primary residence. That isn't going to produce any income, so might not be the best choice to borrow from the 401K in this instance.

[disneysteve]

There are many pitfalls to borrowing from a 401k.

First there is the stuff Nutria mentioned above.

You lose the compound growth on the money you pull out which can have a big impact on your retirement nest egg. The younger you are, the bigger the effect that has.

TH said, "pay yourself back at whatever interest rate you choose."
This isn't true. You don't make up your own interest rate. That is determined by the plan administrator and is typically 1-2% over prime.

Some plans don't allow you to continue contributing while you have a loan outstanding or reduce the amount, so you could lose out on future growth that way, including the company match.

If you leave or lose the job, you need to repay the loan within 60 days or it gets counted as an early distribution and taxed accordingly.

Just don't do it. I realize it worked for TH for investment purposes, but that's a big risk and not worth it for buying a personal residence IMO.

[Singuy]

Some plans don't allow you to continue contributing while you have a loan outstanding or reduce the amount, so you could lose out on future growth that way, including the company match.

If you leave or lose the job, you need to repay the loan within 60 days or it gets counted as an early distribution and taxed accordingly.

These are the only two things to be cautious about when borrowing out of a 401k. The other stuff like being double taxed or what not is a wash. The article didn't account for the fact that when you dump money into your 401k, you dump PRE-TAX dollars in there so from a 4k income, you can expect to dump 6k in pre tax. This 2k difference is then made up when you use post tax money to pay it back. Now if the economy keeps growing and if there's a positive return, the 2k extra you have dumped in pretax would compound GREATER vs 4k post invested in the same markets. This is why Roth have a hard time keeping up with a 401k even though you are taxed at 59 with a 401k.

So if you're not going to get fired, and the company does crazy matching(most don't btw, they only match to a certain percentage and also you can only dump in 18500/year anyways so 4k/month will surpass that real quick)..then your 401k idea is not terrible per se..but there are too many caveats to think about.