9

Question

I am saving up for a downpayment on a house to be used in 1 year's time from now. I have $20K and I want to have $60K, I know I won't have all of it but I want to try. Even if I don't get to $60K I may get close enough so that I avoid PMI, that is one of the primary goals.

How can I determine whether it makes sense to reduce/eliminate 401K contributions for the next year and put that money towards the downpayment fund, then resume normal 401K contributions once the dust settles on the house purchase?

Background info

I currently contribute 15% of my income to a 401k. I have a 10% company match on the first 10% of my contributions. My income is about $100k/year before taxes.

As stated before I have $20K saved up for a downpayment on a house. This number does not include my 401k nor does it include my separate emergency fund.

I am 30 and I have $25K in my 401k. In the future I expect to be able to contribute $15K or more to the 401k per year.

Edit:

My 401k match is $82 per month - that is 10% of my 10% - not a great match.

I calculated PMI on a $300K mortgage with several downpayments.

Downpayment: $49K, PMI: $79/mo. In this scenario the gains from the company match ($82) and the losses from the PMI basically cancel each other out.

But, what if I can't make a $49K downpayment - what if the difference is between a downpayment of say, $35k and $46K?

Downpayment: $35K, PMI: $134. Downpayment: $41K, PMI: $131.

More, but not much. God help me if I don't put up 10% of the loan value, though:

Downpayment: $29K, PMI: $205.

Based on this new information, I'm leaning strongly towards completely stopping all 401k contributions for the next year. I have $20K now and I'll have an additional $11K in a year by holding all 401k contributions until then. That puts me at $31K which is barely in the 90% LTV territory, but being in that territory is much better for my PMI bill than being below 90%. I'll then continue to save on top of that, and we'll see how close I get. Any thoughts on this strategy, or my calculations above?

Chris W. Rea
  • 31,671
  • 16
  • 102
  • 190
Jeremy
  • 1,033
  • 1
  • 10
  • 23

4 Answers4

9

One option is to drop the percentage deposited into the 401K to get the maximum match, and put the rest into the house fund. The amount that will accumulate for the down payment will not be as great, but it will not be as devastating to your retirement funding as a total halt. With each paycheck you decide not to contribute to the 401K, the money the company would have contributed disappears.

Assume that you will reduce the 401K contribution by $5K, and you have a marginal tax rate of 25%. That will allow you to put 75% of 5K into the home fund, or $3750.

Keep in mind it is easy to get a loan for a car, or for a house, or to pay for college; but very hard to get a loan for your retirement.

JTP - Apologise to Monica
  • 172,273
  • 34
  • 296
  • 560
mhoran_psprep
  • 139,546
  • 15
  • 193
  • 389
8

How can I determine whether it makes sense to reduce/eliminate 401K contributions for the next year and put that money towards the downpayment fund, then resume normal 401K contributions once the dust settles on the house purchase?

You'll have to look at your marginal tax rate to assess how much the government will take for each dollar you decide to receive instead of put into the 401K along with at what point do you get bumped into higher brackets. For example, if your marginal rate is 25%, then for each dollar you don't put into the 401K, the government will take a quarter of it in taxes leaving you only 75 cents on the dollar.

If we take your marginal rate as 25%, then the $15K that you aren't going to put into the 401K would mean an additional $3750 in taxes as this is 1/4th of the $15K leaving about $11K to be added to the down payment fund which would bring you up to $31K.

JB King
  • 10,108
  • 1
  • 20
  • 29
7

PMI is a killer. $49K, PMI: $79/mo - this $948/yr is 8.6% of the 'missing' $11K you'd be borrowing, on top of the rate for the mortgage itself.

Not a popular suggestion, but I'd even take a $10K loan from the 401(k) and use it to avoid that PMI. The return on that money to you is over 10%/yr, and you'll avoid the issue of trying to get rid of the PMI down the road.

The match is free money, but not the dollar for dollar match on first 10% as we initially read. You've edited to be clear, you deposit $10, they give you a dollar.

If a house is what you want, I agree, do everything you can to save for 20%+ downpayment. Once you are in the house, I'd then try to get back on track with the retirement savings.

Depending on your timing, the other thing to consider is to fund the 401(k) to the maximum. You are just over the 28% bracket, so for easy math, let me assume 25%. You take $16K and pay tax, and you're left with $12K or less. But deposited to the 401(k) you'd have the full $16K, with the ability to borrow $8K of it in a ten year loan. There are no 'make up' contributions for the 401(k) account, not till age 50, a bit higher limit. This approach would let you come out the other end with no PMI, a short term (10 year) low interest 401(k) loan, and the mortgage. A 5% $240K 30 year mortgage is $1288/mo, $15.5K/yr, well below your limit. You should be able to pay off the 401(k) loan faster than the 10 years, and have a much better balance in the account with this approach.

(Yes, the above has far more risk. A loan that's due if he loses his job. A bit worse than just having the mortgage on the house, but that in itself is a risk until the emergency account is funded 6-9 mo)

JTP - Apologise to Monica
  • 172,273
  • 34
  • 296
  • 560
  • Can you help me understand how funding the 401k to the max and then taking a 50% loan puts me ahead in the end vs not funding the 401k and taking the cash? I believe my job is quite stable but having the entire 401k loan of perhaps $20k come due ASAP would pretty much leave me penniless. If the reward is really good, I'd consider it, but otherwise I'm likely to play it safer. My emergency fund which isn't getting touched by this home buying exercise has $10k in it. – Jeremy Jul 23 '13 at 19:56
  • Over the next two years, $30K can give you $22.5 net cash, or fund a $15K loan. If you project out to retirement, the $30K over 30 more years would be $300K (at 8%/yr return). It's easier to keep the money invested and have 10 years of $160/mo (at 5%) payments, than to try to make up for the missed deposits. As I stated, this is just food for thought. The conservative answer is to cut the deposits. Either way, I'd encourage you to avoid PMI, and deposit 20%. (Although we missed the discussion - what are the expenses within the account? If above 1%, I retract the whole line of reasoning.) – JTP - Apologise to Monica Jul 23 '13 at 20:14
  • Makes sense, thanks! Another consideration that I just considered is the volatility of the money - if I save for a year in my 401k and something crazy happens and the stock market tanks, I could lose a significant part of my investment. – Jeremy Jul 23 '13 at 20:36
  • The deposits intended for the loan should be in the short term fund. This has to be one of the choices. It's in the 401(k) of course, but not 'long term' money up front. While it's still in that fund, you'll actually hope the market tanks, and you'll average in over time. – JTP - Apologise to Monica Jul 23 '13 at 21:55
  • Terrible advice to take a 401K loan. What happens if you lose your job or your company goes bankrupt? You have to pay back the loan, without a job, or pay taxes and penalties on the outstanding loan amount. – Pete B. Jul 26 '13 at 19:16
  • Pete - I was trying to keep an open mind on all options. If you lose your job, there's a mortgage payment that eclipses the size of that loan. The loan isn't right for most, but for those with jobs are secure and can raise the money on a job loss, it might be better than stopping deposits. Need to carefully look at the numbers. – JTP - Apologise to Monica Jul 26 '13 at 20:23
0

The others have given you some good advice. If you decide to take from Peter 401k to pay Paul Mortgage, then you should understand exactly how it impacts your retirement nestegg and what it will take to get you back on track.

I created a google docs spreadsheet that shows your current track to retirement if you don't alter your 401k contribution. The spreadsheet assumes a 6.5 % market return and factors in 1.5% pay raises for you per year (these amounts are debatable, so you might want to tweak them).

Retirement projection

At your current savings, you are on track to retire with 2.5 million. If you withdraw 4% of the balance per year in retirement, that gives you enough of a nestegg to withdraw 100k per year, which is what you make now (without accounting for inflation).

Suspending your contributions for 1 year starting now knocks more than 150k off your nest egg. Suspending for two years knocks it down by more than 300k.

I encourage you to download the spreadsheet as excel and play with it. Hard code 0's into the contribution column for the years that you won't save, then jam a number in for the year that you intend to resume saving. The rest of the rows will pick up from that point.

bigh_29
  • 1,116
  • 7
  • 8