Don’t cash in retirement account for down payment!

Comments(0) By Mike Miller •September 20th, 2008

Homebuyers frequently use retirement money toward the down payment on a house. But think before you leap. Buyers justify this by saying they want to cut the monthly mortgage payment and have a smaller mortgage. Buyers also use this tactic to avoid having to take out what’s known as a jumbo mortgage, which generally comes with a modestly higher interest rate. Jumbos tend to be classified as exceeding $417,000. Buyers may also use retirement funds to avoid private mortgage insurance, PMI, by placing at least a 20% percent down payment on the home right off the bat.

These are all valid reasons. But do they really justify borrowing from your future? When it comes to saving for retirement, you usually end up with more if you defer taxes until you need the money. So the more tax-deferring you can do, the better. The funds for your home, if possible, should come from elsewhere.

An example brings the point home:

Take a penny. If you double it, you get two cents, if you double it two more times you get eight cents. After 30 times, you end up with a tidy little $5.37 million.

Now do the same exercise, and impose a 28 percent tax on the gain after each doubling. You end up with $1.32 after 10 doublings, and $67,659 after all 30. That’s a nice sum, but not quite $5.37 million.

Unfettered growth really pays off.

This isn’t the only drawback of breaking into the retirement nest egg. If you take money out of an IRA or 401(k) plan, before age 59 ½, you likely face a 10 percent penalty from the IRS on top of whatever the normal taxes are. You can borrow from these plans, and that may make sense at times, but you have to pay it back. What’s more, your mortgage lender may restrict your borrowing ability as a result.

So tinkering with your mortgage may not justify cutting into one of your most-important employment benefits, which is your 401(k) plan.

You may find more-attractive alternatives to improve your mortgage.

Investigate the possibility of using a “seller contribution.” Here, the seller can pay your closing costs or build these costs into the purchase price. This may reduce your need to pull money from a retirement account. If you cannot put enough money down to avoid paying PMI, then consider paying the PMI premium rather than tapping your future. With some appreciation in the value of your home and/or prepayment of your loan, you can eliminate this fee quickly. If you want to avoid the slight rate increase that comes with a Jumbo mortgage, consider taking a second mortgage for the difference.

You should try to max out your 401K, SEP and IRA every year.

After all, you’ll enjoy that new home even more knowing that your retirement years will be comfortable.

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