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Should I Drain My 401(k) to Buy a Second House? – Armando

Armando

“Dear Steve,

I am currently 38 years old, and married to a 24 year old. Between us we have about $25,000 in debt. My 401k is currently valued at $51,889, mind you I have been puting almost $600 in a period just to keep it at this level as most of it goes keeps going away do to stock levels.

We do not own a home. We would love to own a home, but it is nearly impossible to do that here in Southern California. For that reason I am relocating to another state, one with lower housing costs and a lower cost of living.

I have been thinking of borrowing aginst my 401k for the down payment to buy a home in the new state, but I would have to buy the house as a secondary, and not primary, since i do not have a job out there as of yet and the current approval I have is for the income I have here.

Using my current income as a base I am saving $500 a month by moving out of state, but mind you this might be an inflated number as i am sure I will not get as much money in pay out there. So i am guessing it will actually be around a $300 a month savings.

My wife does not work out here cause daycare is outrageous for our 2 year old, so she stays at home and watches a fwe other kids for extra income. In Missouri, where we are moving to, she would be able to get a work from home job which would allow her to bring in income, save in a 401k as well, and still care for our 2 years old.

I have cut just about everything out of our budget to cut down on costs, but currently it is not enough, I currently am only able to save $20 a month after paying rent and bills. I have thought of looking into a much shadier part of town to rent in, but I also have a 6 year old, so I have to consider schools a mojor factor in all my desicions. i do not want my child to have to suffer because of my mistakes.

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The current 401K I have has only been in existance for the past 5 years, as my current employer just provided this as a benefit. They use to match all contibutions, but with the economy they stopped that a little over a year ago and now just pay to have the accounts managed. I did a bankruptcy 4 years ago, and married into the debt.

So I am now down to one of two choices, I can move out to Missouri, and roll my 401K over into whatever my next emplyer will offer, continue to pay off my debt slowly, then in a year or so use it as a loan option to buy a home. Or i can cash out my 401K, pay the 10% penalty and taxes and pay off my debt in almost full, i figure I would have about $5000 left. From there i can start a new 401k with max contirutions, and be able to save the $1000 I currently pay to all my credit cards. I still have a good 32 years before i retire, so I figure that as long as i get a job that provides a 401k that matches contibutions I could regain all my money and more within a few years.

Like i said, currently I put money into my account just to keep it from shrinking in size, so really I am just reducing my taxable income while not gaining anything else. I have been racking my brain for weeks trying to figure out if i should just cash out and pay off my debt, then save , save, save to build up my own down payment on a home. I figure that within 2 years I could have a small 401k to borrow against, and at least $15,000 in bank from both of our payrolls. Or should I keep the 401k, and continue to pay $1000 or a little more a month on credit cards?

Armando”

Dear Armando,

Thank you for writing to me.

I think the major issue here is that you are over-saving on a monthly basis.

401(k) accounts, like other investments, will grow and shrink as the stock market does. Actually what you have been doing is chasing the stock market dow by investing more money to keep your account at the same balance. On one hand this has been a good thing for you. You are buying more stock and shares for less than you once paid. When the stock market returns to old levels, which it will in your lifetime, those shares you are purchasing now will be worth a whole lot of money.

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I certainly understand the desire for homeownership but to be honest, I think you are going about this is in an obtuse way.

What I’d much rather see you do is the following:

  1. Contact your 401(k) company and see what funds you are invested in and talk to an adviser about changing your investments to better meet your investing goals, i.e. long-term.
  2. Stop current withholdings into current 401(k).
  3. Put money you were investing into a savings account.
  4. Rent, do not buy, in your new area. Get your feet wet there, look around and get settled with jobs after the move.
  5. Once you get re-employed then roll you 401(k) into the new plan.

But Armando, whatever you do, don’t take the money out of the 401(k) in a disbursement or a loan. A 401(k) is not a liquid savings account. It is a retirement account. If you want to build up a deposit or have an emergency fund then you need to be putting money into a boring old savings account where you will not be penalized for taking the money out. The reason you are so heavily penalized is exactly to prevent you from taking money out until you retire and need it to live.

When you move to Missouri and start contributing to a new 401(k) I would suggest that you invest only up to the level that your employer matches your contribution. Put the rest of the money you can afford into that savings account I just mentioned. This will let you build up your down payment.

This approach will let you move, get adjusted, get new jobs, find a local house, qualify for a primary mortgage at the lowest rate and have liquid cash to tap when you need it.

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About the author

Steve Rhode

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

1 Comment

  • Thank you for the great advise. I have been arguing with my wife about not cashing out, but she just thinks that this is the quickest way to financial freedom. Hopefully your explanation will help her understand why.

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