Borrowing from 401K vs. PMI

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Submitted by EmilyHicks on December 17, 2010 - 8:00pm

Earlier this month I asked about whether we can buy a home with only 10% down payment. We have no problem making monthly payment but for many reasons, we only have about 10% down payment plus some extra money. After reading your answers, it is most likely that we have to a few hundred dollars a month for PMI.

My fiancee and I saved early and a lot but most of it is in our 401K accounts. We have close to $300,000 in our 401K (we are about 30 yr old). I am thinking aobut borrowing about $50,000 from the accounts and use it as down payment. I know many people advised not touching your retirement accounts but I really don't want to pay PMI and want to avoid it if I can.

Current the interest rate for our 401K accounts is 2.75%.

Do you think this is a better way to go than PMI?


Submitted by patb on December 17, 2010 - 9:05pm.

i've been thinking the same things too.

Submitted by scaredyclassic on December 17, 2010 - 9:34pm.

I borrowed this way. It was all in cash anyway. I saw it as an alternative investment. Interest is paid to yourself.

Submitted by joec on December 18, 2010 - 1:13am.

I've borrowed from my 401k before as well. I think in terms of the cost of getting money, this isn't a bad way to do it. For a home purchase, I think you could also give yourself longer loan terms as well to stretch out your payments if you need to.

I did notice various small fees they charge, but in the grand scheme of things...for 50k, there aren't many cheaper options to access money. Especially since you're paying the loan interest back to your account.

If someone mentions it, in regards to double taxation, here is a write up about that as well (there isn't any):

Guaranteed savings interest is very low now so tapping any cash earning low returns and saving $300 on PMI or whatever it costs sounds like a good idea to me.

Submitted by AK on December 18, 2010 - 1:40am.

Run the numbers very carefully. Keep in mind:

1. You're paying back the 401k loan in after-tax dollars.

2. The interest paid on the 401k loan isn't tax-deductible.

3. If you change jobs or get laid off, you may have to pay back the loan in a lump sum or pay $$$ in taxes and penalties.

4. PMI isn't forever. In the event that prices go up even modestly you should be able to get it removed after a few years.

5. There are lots of PMI options, including single-premium MI.

6. Oh wow, I just realized that I get to deduct my VA funding fee. Ka-ching!

Submitted by temeculaguy on December 18, 2010 - 4:31am.

Just do all the math and see what works out best, it can vary based on your individual tax situation and if you buy the house that tax situation will change as well. Get last years tax software, get your taxes then run the two scenarios, check the fees and see which scenario wins.

Also factor in that PMI is deductable now.

Normally I would tell people to leave their retirement money alone but I like your numbers, a couple of 30 year olds sitting on 300k, nice work. Obviously you are savers, you'll get it back. Most people need to be kept from their retirement savings because they will blow it, most 30 year olds are just getting into the groove of saving if at all. The 20's are a hard age financially, it's often spent partly still in school, then in entry level positions and it is those years you need to buy stuff because you don't really have anything. Plus when you go from zero income to something decent, it vanishes in that lottery winning feeling, at least it did for me. I'm just guessing here, but if 50K is 10%, then you are buying a house for about 500k, for a 30 y.o. to buy a house and they have already saved 60% of the total cost essentially, that is such a stable lifestyle. I'm proud of you.

Submitted by CafeMoto on December 18, 2010 - 9:12am.

I talked with "home loan Sheldon" recommended by piggs here and borrowing from my 401k is exactly what he told me to do if I moved ahead (last year). Would not hurt to look him up and chat with him. He was insightful and not pushy.

Submitted by scaredyclassic on December 18, 2010 - 10:00am.

I don't see a downside or tax implications ... if the money is just on cash in 401k and you only wouldve had pmi a year, you're getting a guaranteed return on your money of the pmi paid minus any tax ded u woulda had. If pmi is no more u can pay back the Loan to the 401( in my case we had the cash on hand and in the acct but just wanted to do something w retirement $ other than 401k available shares. Allowedm
to keep cash in various commodity metal rugs and not feel pinched for a savings fund . The primary risk as I see it is not being able to pay off the loan in a pinch but minus that risk it looks smart for certain types...

Submitted by ocrenter on December 18, 2010 - 10:50am.

401k interest rate does pay back to your account. So it is a very credible way to access much needed money.

Even if PMI is deductible, remember you will only get a portion back (say 30% if that is your tax rate).

of course, the portion of the 401k you remove from the account will not be in the market generating passive income.

however, if we are merely looking at a one time loan that will be paid back rather quickly within 1-2 years, I don't think that would be of significant issue for you. the stock market is unlikely to go anywhere dramatic over the next couple of years.

Submitted by joec on December 18, 2010 - 11:00am.

Sheldon explained the point on having to repay the loan immediately or face early withdrawal penalties and income taxes. That is the biggest risk with this option I feel.

One thing not mentioned yet is that your loan isn't on your credit report, at least it wasn't in my case...

In the short term, if your job is stable, this is probably one of the lower cost of accessing a large amount of funds.

There's also the 60 day rollover option as well with IRAs.

Submitted by AK on December 18, 2010 - 12:14pm.

Ah yes, looks like the PMI deduction is getting extended for another year.

Submitted by UCGal on December 18, 2010 - 1:18pm.

AK wrote:
3. If you change jobs or get laid off, you may have to pay back the loan in a lump sum or pay $$$ in taxes and penalties.

This happened to a good friend. She closed on a house and a few weeks later got laid off. Not only did she not have the mortgage money - she was scrambling to come up with the downpayment money she'd borrowed from her 401k - or else she'd have had to pay a 10% penalty.

Look really really hard at the job security issue. And make plans to repay if you have any plans to change jobs before it's paid back. It definitely ties you to your employer.

Submitted by Effective Demand on December 18, 2010 - 1:19pm.

Normally, I would regard retirement accounts as sacred. But the amount needed relative to your savings isn't that much. You would have to calculate the opportunity cost (return you would have gotten if the money remained in the account) vs PMI cost minus deduction (PMI deduction might not apply to you due to income restriction).

Submitted by moneymaker on June 6, 2013 - 2:03pm.

Dear Emily,
Looks like if you went ahead with the cash out then you would have been better off leaving the money in. It would have gone up about 30% by now which would have been $15,000. I too am about to gamble to get rid of my PMI, I am refi'ing into a shorter term, slightly more expensive loan to get rid of it. I may have been able to get rid of it in 1 year as long as home prices continue their upward climb. I'll report back in 1 year to see if my choice was a good one.

Submitted by spdrun on June 6, 2013 - 4:54pm.

You can do a LOT better than merely buying a home, assuming you're not already self-employed...

Sitting on 300k cash and not using it to start a business of some sort, whether it's property rental or something else entirely, is stupid in my book. If you're 30, retirement isn't for another 35 years. Better to position yourself to have investment/business income NOW, so you're not beholden to some arseholes at your office all the time.

Looking at it, with 300k in the 401k, won't that meet minimums to keep the plan even after leaving the job?

If I had that much cash equivalent available, I'd be putting it in properties capping 8-9%(*), borrowing against the properties at 6% principle + interest, 75% LTV, and having at least $40-50k additional pre-tax investment income minus the interest on the loan against the 401(k). 2.75% IRA return is for the birds.

With that kind of investment income, you two can at the very least have a VERY nice vacation one or two times per year. Plus having it pay for most of your housing expense if you choose to live frugally. As far as primary home, I wouldn't spend more than $175-300k on a 2 bedroom well-managed (but not ritzy) condo in your situation.

(*) - they exist currently. Just bought one a few weeks ago in SD. Less deals of that type locally to you now, but plenty of that sort of thing in halfway decent areas surrounding various East Coast cities right now.

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