Think twice before borrowing against 401(k)
Q: Is it wise to withdraw funds from a 401(k) to make a down payment?
A: Withdrawing funds is very unwise, as you would be hit with taxes and penalties, but borrowing against your account might make sense, provided your employer allows it. The cost of borrowing against your 401(k) is not the loan rate, which you pay to yourself, but the return the money would have earned if left in the account.
The risk is that if you lose your job, or change employers, you must pay back the loan in full within a short period, often 60 days. Otherwise, the loan is treated as a withdrawal and subjected to taxes and penalties. Loans from a 401(k) cannot be rolled over into a 401(k) account at a new employer.
Q: What are the costs and benefits of making a larger down payment than is required?
A. The cost is measured by the rate of return you could earn on the money if you invest it rather than use it for a larger down payment. The benefit is measured by the mortgage interest rate, as that rate determines the interest savings on the amount you don't borrow.
If you increase your down payment by $10,000 on a 4 percent mortgage, you earn 4 percent on the $10,000 you didn't borrow.
A possible additional benefit arises when the larger down payment reduces the cost of the loan by lowering either the mortgage interest rate or the mortgage insurance premium.
My calculator 12a shows the total rate of return on investment in a larger down payment taking account of any such cost reductions.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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