A little over a year ago, I took what some would say is the most irresponsible financial step one could make. I financed my down payment with a loan from my 401(k) retirement savings account. And now I am writing a post on how it was the best decision I have ever made. In this post, I hope to share with you a lesser known way of pulling together the chunk of change you need to make a home purchase.
Disclaimer: I am not a CPA, CFA, or acting as your attorney. I am just a gal who with my guy decided that this option was the best for us.
For the five years before we purchased our apartment, I worked very hard to pay down college and law school debts, and build my 401(k). My employers made it easy to transfer money out of my regular paycheck on a pre-tax basis, and into a 401(k) that I passively managed (aka looked at once every few months…not recommended, but we only have so much time right). I began to invest in this retirement savings account in 2010, when the market was still very much in recovery mode and many value stocks remained low. Over the past few years, the market has rebounded significantly, and with it I saw significant gains in my holdings, which were bolstered by my continuous and automatic contributions. I watched my portfolio grow to six figure amounts and was content to keep watching it growing.
With the stock market rebound, came the housing market rebound, and while sales numbers and prices stayed low, rental prices in New York City, where we live, began to skyrocket. My rent increased by $1000 in the seven years I had lived in NYC since moving back from law school. With no cap in sight and with certain home prices being affordable but on the rise, biz·e·hubs and I went from lazily thumbing through the Times Real Estate Section, to subscribing to Streeteasy, Zillow, Trulia, and every other real estate resource out there. We voraciously consumed any updates and alerts about apartments in our desired areas and went to more open houses than we care to admit. Finally, we fell in love with THE ONE. It was priced extremely well, had the space we wanted, and the bones we needed. But how were we going to pay for it? All the while I was saving for retirement and furiously paying off debts, I wasn’t putting much away in short term or project based savings. For me, it was just more important to get rid of debt. But that strategy left me with little extra cash lying around for a
rainy day -er hurricane season.
Thankfully, before we started the apartment search in earnest, I researched just about every way to finance home purchases. It seemed like everyone in America knew about FHA loans and how little you had to put down to get the house of your dreams. But that wasn’t an attractive option for me. My money is my money and I didn’t want to pay PMI for any period of time just so I could get into a house. (I also had just watched the Big Short.) Not only that, but being a New Yorker, an FHA loan was really not a viable option. Coops are king in NYC, and good luck finding one that let’s you in without 20% of purchase price in cold-hard cash, not promises and ponies. It was frustrating knowing that I was sitting on a mound of untouchable cash that I had meticulously accumulated and couldn’t do anything with it. Hey, I consider myself a responsible person and I wasn’t looking to blow my retirements savings on a yacht or Ferrari. I just wanted to buy an apartment.
So why couldn’t I?
Turns out, I could. My research led me to various resources which explained how I, as a first-time homebuyer, could use a portion of my qualifying retirements savings to finance a down payment on a home. And I could do this without being penalized! (Retirement accounts are not supposed to be touched, well, until retirement. Dipping into them too early will usually incur a penalty). I used my 401(k), but there are other options for IRAs as well. When using a 401(k), the IRS will generally allow a qualified person to use the lesser of (1) one half of their account balance, or (2) up to $50,000, to put towards the purchase of a home. Unlike IRAs, where the disbursements are not required to be repaid, money taken from a 401(k) or similar instrument is a loan, and one that comes with some pretty specific and potentially scary repayment terms.
Armed with full information and the enticing knowledge that I could successfully purchase a home without the normal nest egg, I sat down to weigh my options. I completely got the naysayers who said that I was biting off more than I could chew and jeopardizing my financial future. But there were serious pros to me using my 401(k). I had saved that money. It wasn’t in a liquid bank account, but it was nonetheless the result of my automatic, financially sound behavior. I also was paying a lot more in rent than I would be in a mortgage + additional homeowner expenses, but accruing zero equity in my tiny rental. Today the apartment that we own is worth 1/3 more than when I bought it. The very real risks espoused by many were also not applicable to me: my plan does not require immediate repayment if I leave my job or am terminated, and if I have to I can continue to make loan repayments via a bank account instead of paycheck withdrawals. So I took a leap of calculated faith.
That decision was the hard part, but the follow-up was relatively straightforward. The paperwork that you will need to do to get these funds in place are completely dependent on your retirement plan, but once I received the cash disbursement, I treated it just like any other receipt of cash, deposited it into my bank account, and wrote a certified check against the amount, which I brought to closing shortly thereafter. It was a straightforward process and allowed me to secure the apartment of our dreams, without owing more money to outside lenders or (over)paying PMI.
A year later, I am still 100% confident it was the right decision for us. Getting into an apartment that has already appreciated, in a neighborhood that is growing, all while realizing new monthly savings on our living costs was worth the temporary dip in my 401(k). And don’t call my psychic, but our choice was really well timed given that shortly after I took the disbursement, European market instability caused many portfolios (including mine) to take temporary hits. It was actually fortuitous that I had some of my money in real estate and not in my 401(k) at that moment, but I digress…
Should I buy my house with my retirement savings?
If you are interested in using retirement funds to finance all or part of your downpayment, you should keep a few things in mind:
- The IRS mandates limits as to how much you can take from each type of retirement account.
- Ask yourself, “Am I a qualified first-time homebuyer?” Even if you have already owned a home, you may just be one!
- You will be sacrificing gains made on the amount that you take out. Compound interest is king with any investment, and the less money you have in your account over time, the less you are compounding. Weigh your PMI and other cost of living savings against this and base your decision to take a retirement account loan on the result
- You need to be very organized and overly prepared to take out a retirement account loan. There are a number of moving pieces to get to closing and retirement account loans only add to the chaos. If you aren’t carefully monitoring the situation, you could easily run out of days that the IRS gives you to reinvest your disbursement as a downpayment and be forced to pay the early dismemberment penalty (and nobody has time for that)!
- Financing your downpayment via a retirement account loan is a tax intensive process and the rules could change at any time. I became knowledgeable about the tax laws in place when I executed my transaction. They may be different now and may change in the future. It is important to stay abreast of what the IRS rules are when you are ready to buy your home.
- The 401(k) disbursement is a loan, and as such, you will have to repay it, with interest. But don’t fret, the interest on the loan is paid into your account. This technical point didn’t make any difference to me during my decision making process, as I was simply paying myself. There are time limits to paying the loan, so you must consider your ability to make those payments when deciding if this is the right option for you.
- Your retirement account loan may be called if you leave a job (voluntarily or not). In the course of my research, I learned that my account holder will let you continue normal repayments without penalty (whether I have a job or not). Your account may not be as flexible. Keep this in mind and make sure you have a plan in place to deal with a balloon payment should you leave or be asked to leave your employer.
Again, I am not an or your accountant, investment advisor, or attorney. I am not offering advice on what will or is likely to happen if you buy a home using retirement account monies. I just hope that my story gives you a bit more color on how one can happily buy their home with a 401(k) loan and feel like they made a wise financial decision.
Are you a homeowner or on the market?
What creative ways did you employ to come up with the good ole 20%?