401k withdrawal for home down payment

[LivingAlmostLarge]

A friend asked if they should take out from their 401k to put down on a house. I said yes. Their financial advisor suggested it. Mind you if they do this they will be emptying most of it and he won't make any money off of them. But the reality is that i think it also makes sense for them.

The house they want to buy their landlord offered for $900k to buy. The market value is solidly $1.2M. The tax assessment is $1.275m. The landlord is giving them a deal so they can stay after living there 15 years. They need at least $180k down and the only sticking point besides taking out from their 401k is that the monthly note is going to be very very high. Probably 50% of their take home pay if not more. The down payment they will likely need to take out $275k to cover the taxes and penalties. To afford the mortgage they will likely need to substantially scale back their lifestyle and not vacation, not save for retirement, or college.

I'm not sure what they want to do. I said it's okay to take out the 401k money because it's just moving their assets around. BUT i also said only they can answer if they can afford the monthly note. They have to sit and do the budget and decide what's important.

Is it really not acceptable to withdraw from a 401k to buy a home? Where do you guys stand? And that is a separate question than affording the home. Mostly because only that person can know how they spend their money and if they can truly afford a house that is 50% of take home pay.

[Fishindude77]

Poor idea all the way around.
401k Is intended for retirement income and withdrawal from it will result in taxes and penalties. A big part of what makes a 401k work is the fact that you are leaving it alone and invested for the long term.
Would be wiser to halt or seriously curtail the 401k investing and start setting aside a savings for home down payment.

As bad as the 401k withdrawal idea is, I see other red flags:
* High monthly payment 50% of take home pay.
* Have to scale back lifestyle.
* Won't be able to save, vacation, retirement, etc.

Just because they are getting a decent deal on the home doesn't make it a wise financial decision.
Where are they going to come up with $$ when it needs a new roof, furnace, etc.?

In summary, it doesn't sound like they can afford this house unless they want to buy it and flip it quickly taking advantage of the reduced price landlord is offering. But still a bad idea to tap the 401k to do so.
Would also be kind of a rotten thing to do to landlord.

[disneysteve]

Sounds like a terrible idea. Decimate your retirement savings to buy a house you can't afford.

I'm generally of the opinion that dipping into retirement money for anything other than retirement should only happen in a truly catastrophic situation, like literally saving a life. As soon as you start viewing your retirement accounts as piggy banks, you're doomed.

[ua_guy]

I would think the monthly PITI might be an issue getting approved for a loan out the gate, and even if it was approved, I don't recommend being "house poor" in the current uncertain climate. Here in the Northwest, home inventory is building and it's turning back to a buyer's market. I don't think a market correction of 20% is out of the question. But, the question was about borrowing from a 401k.

I'd be lukewarm on the idea *only* if they weren't going to pay penalties. I recall there used to be first-time homeowner programs that allowed folks to borrow from retirement funds without penalties. I still don't think it's a sound idea. I could see some strategy if they intended to stay in the home for their retirement years and wouldn't still be paying on it. But even that's a risk. Or, if a significant increase in income/opportunity was expected in the coming years, but again, waiting for that feels riskier than usual these days.

Retirement funds are protected in bankruptcy generally, a home is not. So there's that to consider also.

I gather they enjoy the home and don't want to lose it after living in it and paying rent for so many years. I assume landlord will otherwise sell it, and kick them out? I feel for them in that regard, and I'm sure it's tempting because technically they have the money to transact and realize this dream of theirs, but it might put them at a significant disadvantage overall. I worry if they aren't able to contribute to retirement during prime earning / investing years what buying the home might represent in an overall opportunity cost to their futures.

[riverwed070707]

For conversation sake, how does the mortgage payment compare to what they're currently paying in rent? How old are they?

Overall, terrible idea that sounds like it will set them back decades in financial independence and make them stuck with a house they can't afford. A house is not a retirement plan. They could borrow against the 401k, but 1) that further increases the monthly payment because you're also repaying your DP and 2) if they had a job loss, they'd be required to repay the loan in full. Why start over on retirement savings? Withdrawing the money outright with penalties means starting over on retirement savings while knowing they won't have much left over to replenish those funds. I see no upsides.

[myrdale]

NO!

There are very few reasons to withdraw money from a 401(k).

1) You (or your spouse or child) have cancer (or the like) and are otherwise going to die without treatment.
2) You have lost your job and are facing foreclosure.
3) You have a major home repair (pretty much septic or roof) that must be completed.

And in all three cases I would consider more borrowing against and paying back.

Don't do it! They chose to rent for 15 years and now it has come to an end. This isn't their "home" it is their landlord's house. It might as well been an apartment in a complex or a trailer in a rental park.

And don't think the land lord is doing them any favors either. If the house can sell for $1.2M then he would sell it for that, rather than handing them $300,000 in equality.

Imagine if they found a $500,000 house how much further they would be ahead in 10 years.

This house is a curse and they should run from it!!!

[disneysteve]

I said it's okay to take out the 401k money because it's just moving their assets around.

I don't think it's as simple as that. Assuming they are invested well, the 401k money should be growing at a decent pace, 6-8%/year. If they take that money out and use it to buy the house instead (and pay taxes and penalties in the process), they will have moved their assets into an illiquid form that at best might grow 2-3%/year and also raise their monthly expenses considerably. There's no comparison. Buying the house is a bad idea no matter what and buying it with their 401k funds is committing financial suicide.

[LivingAlmostLarge]

1. They are 48 years old.
2. The landlord wants to give them the deal and the $300k built in equity knowing they could get more. They said they'll only give them the deal or sell to a developer for the market rate and walk way. The landlord is a widow now and is disposing of all her properties now that her husband died last year. She plans on selling in the next year so they don't have enough time to come up with a down payment.
3. 401k - can't be a loan you can max borrow $50k, not $180k. So I guess they could borrow $50k and then take out less.
4. Without the down payment no way will they be approved. They might only barely be approved anyway with the PITI of 50%. With nothing down they are looking at $8k for a mortgage payment and I don't think they would be approved. They will be on the edge with 20% down.
5. They currently rent their house for $2000/month. The mortgage payment will be $6500-7000 it appears for a $900k home. It will severely crimp limit their lifestyle.

The upside is that they have a built in $300k equity for buying the house they could flip and sell for more immediately if need be. That's the upside. So Disneysteve, the upside is that they have an immediate 100% ROI on the $180k down payment though illiquid. Then there is the leveraged asset growth instead of growing the 401k. Yes a 401k grows 8% a year but you are leveraging 20% of a house down to have to have it grow much faster on the 20% down and still growing at the 3% rate. The rest of the it is being built by paying down the debt and building equity.

So there is tremendous upside for them in this home purchase. Most people don't get a 25% discount on the house. So the return is substantial. The issue i see is affording and qualifying for it. But everywhere says they can afford it. I don't know how but they apparently can.

[ua_guy]

In the current climate, that's too close to the edge for me. They're not "just" moving assets around, they're taking a massive penalty and paying tax on 401k withdrawals to invest in an asset which is likely to only tread water for a while, or potentially lose value. Meanwhile, paying thousands and thousands of dollars per month in interest which puts them at risk if the financial weather turns truly bad.

IMO 48 is too late to be taking out a 30 year mortgage with that loan:value and ability to repay. They'll be 78 if they ride it to term or spend the next 15 years likely sinking everything they have into the home to pay it down. The opportunity cost is massive compared to continuing to save and invest for retirement. A different solution / much cheaper home is in order.

The story changes if they already have like $5 Million in retirement and they just want the house. But that doesn't sound like the situation they're in.

[LivingAlmostLarge]

In the current climate, that's too close to the edge for me. They're not "just" moving assets around, they're taking a massive penalty and paying tax on 401k withdrawals to invest in an asset which is likely to only tread water for a while, or potentially lose value. Meanwhile, paying thousands and thousands of dollars per month in interest which puts them at risk if the financial weather turns truly bad.

IMO 48 is too late to be taking out a 30 year mortgage with that loan:value and ability to repay. They'll be 78 if they ride it to term or spend the next 15 years likely sinking everything they have into the home to pay it down. The opportunity cost is massive compared to continuing to save and invest for retirement. A different solution / much cheaper home is in order.

The story changes if they already have like $5 Million in retirement and they just want the house. But that doesn't sound like the situation they're in.

why would you suggest taking out at 48 too late? I mean people move and get mortgages all the time. The 15 years on it wouldn't be bad. It would gain an immediate ROI on the down payment. I am playing devil's advocate. I'm not sure I would do it but I want to be fair and look at it from all perspectives.

The return is immediate since they are getting a discout on the house. That if they turned around and flipped it would probably be the best thing. The bigger issue is even if they qualify should they spend that much on a house? The monthly note to me would be the bigger problem. Emptying the 401k I would think would be able to be built up.

[ua_guy]

why would you suggest taking out at 48 too late? I mean people move and get mortgages all the time. The 15 years on it wouldn't be bad. It would gain an immediate ROI on the down payment. I am playing devil's advocate. I'm not sure I would do it but I want to be fair and look at it from all perspectives.

The return is immediate since they are getting a discout on the house. That if they turned around and flipped it would probably be the best thing. The bigger issue is even if they qualify should they spend that much on a house? The monthly note to me would be the bigger problem. Emptying the 401k I would think would be able to be built up.

I'm assuming they'd need to take out a 30-year and you mentioned them already being at the max allowable debt:income with the PITI. If they truly don't have the ability to repay it until almost 80 years old, I'm not sure foregoing retirement investment AND adding mortgage expense in retirement is going to be beneficial.

[LivingAlmostLarge]

I'm assuming they'd need to take out a 30-year and you mentioned them already being at the max allowable debt:income with the PITI. If they truly don't have the ability to repay it until almost 80 years old, I'm not sure foregoing retirement investment AND adding mortgage expense in retirement is going to be beneficial.

That's a valid point and correct they can't afford the 15 year. But you could try and pay more. Also the home appreciation could negate the increasing rent payments.

My problem is i see RE as a way to build wealth. But I'm not sure if that's not a skewed perspective. it just seems like a cornerstone to a secure retirement a paid for home. It can be used to fund nursing home care.

[Fishindude77]

That's a valid point and correct they can't afford the 15 year. But you could try and pay more. Also the home appreciation could negate the increasing rent payments.

My problem is i see RE as a way to build wealth. But I'm not sure if that's not a skewed perspective. it just seems like a cornerstone to a secure retirement a paid for home. It can be used to fund nursing home care.

With the payment at near 50% of their take home pay, having to cut lifestyles, etc. it's very unlikely they will be making extra payments.
The immediate equity gain and assumption that the home will be increasing in value would make great sense for someone that has adequate cash sitting around for a substantial down payment and an income sufficient to handle the mortgage easily. They have neither.
I'm a big fan of real estate to build wealth too, but we must face reality. There are lots of parcels of real estate we'd all love to own, but can't afford. You can't let emotion overrule barnyard economics.

This deal wipes out their retirement savings and buries them in debt repaying a mortgage they can't afford and would still be paying well into their 70's.

[riverwed070707]

That's a valid point and correct they can't afford the 15 year. But you could try and pay more. Also the home appreciation could negate the increasing rent payments.

My problem is i see RE as a way to build wealth. But I'm not sure if that's not a skewed perspective. it just seems like a cornerstone to a secure retirement a paid for home. It can be used to fund nursing home care.

I don't think anyone disagrees real estate can be a way to build wealth... but only if you can afford it and in this scenario it doesn't sound like they can. I'm not sure where its an offset to increasing rent payments if their current rent is $2000 and their mortgage payment will be 3.5x that. If some of their financials were different, you might be able to make a case for this, but they don't have any of the pieces lined up. It doesn't sound like they're on a path to financial freedom in their current situation - the house will make that worse. They don't have enough for retirement at their current age, they don't have a down payment, they can't afford the new mortgage, it will drastically impact their current lifestyle and they will have no money left over to recover. If they could afford a $6500-7000 mortgage payment, where is that extra $5k/mo going now?

If they were 30 my answer might be different.
If they had $2M in retirement my answer might be different.
If they had cash for the down payment and they were maxing retirement contributions my answer might be different.
If their rent was already $7k/mo my answer might be different.

Its a terrible idea. Be a good friend and tell them to go find a place to rent, save up a down payment if owning a house is part of their plans, and then buy a house that's 25-30% of their take home on a 15 year mortgage.

[disneysteve]

My problem is i see RE as a way to build wealth.

When anyone asks how we got to where we are, part of my answer is always pointing out that we chose to buy a very modest affordable home once 31 years ago and we're still there, and it's been paid off for about 6 years now. When we bought our house, the purchase price was about 1.7 times our income. The mortgage folks said we could "afford" more but we knew better than that. Spending more on a house would have seriously impacted our overall finances and not left us nearly as much to invest for the future in assets that grow way faster than real estate values. So yes, buying a house is great when you can afford it, but going deep into debt and stretching yourself super thin to get a house that's way out of your league is a recipe for disaster.