What Experts Say About Raiding Your 401(k) to Buy a Home

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Nest Eggs Broken
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By Amanda Falcone

You've found the perfect house in the cutest neighborhood. And you're tired of writing a rent check every month, with nothing to show for it. All that's keeping you from making an offer on your first home is that big down payment.

So is it OK to use your 401(k) account to buy your first home? Before making that decision, you need to decide if it makes more sense to keep your money in your 401(k)'s stocks and mutual funds, or if you'll make more money in the long term by shifting that money to your primary residence.

Weighing Your Options

Real estate is just starting to recover after the bubble burst on prices during the Great Recession, but it's a hot investment right now: The National Association of Realtors says the median price for existing single-family homes is $229,400 -- up 8.2 percent from the previous year.

That outperforms nearly anything that you'd find in target-date funds that are included in many 401(k) plans; for instance, the Vanguard Target Retirement 2050 fund (ticker: VFIFX), for those who are planning to retire about 2050, has returns of 1 percent in the last year.

Of course, a one-year snapshot doesn't tell the whole story. The markets are in a six-year bull run, but returns are lower this year because of August's correction and concerns that the Federal Reserve will raise interest rates. Fidelity says its average 401(k) account dropped from $91,100 to $84,400 in the third quarter.

Robbing Peter to Pay Paul

It comes down to a decision, financial advisors say, between trying to increase your long-term investment portfolio through your home or through the stock market, mutual funds and bonds held in a 401(k).

Andrea Heuson, finance professor at the University of Miami, says a 401(k) is a better investment vehicle because investors can choose where to invest their money, and they have the ability to get to it quickly in an emergency.

"That is probably not a wise economic decision [to dip into your retirement] simply because, from an investment standpoint, a 401(k) gives you much more flexibility as an investor than a house does," she says.

Taking money from your 401(k) also comes with a big penalty, unless you've turned 59 1/2. Investors can expect to pay tax of 10 percent, which means that money is already lost before the initial transaction. And by draining 401(k) accounts, buyers could also miss out on the magic of compounding interest.

"If it's not one of the worst things you can do, it's close," says Chris Copley, a regional sales manager for TD Bank in Pennsylvania and New Jersey.

Copley says there is seldom a time where he would recommend that a client liquidate a 401(k) account. "That would be an occasion with special circumstances," he says, adding that potential buyers should be able to put 3 percent down plus cover closing costs without dipping into their retirement accounts. If they don't have the money, Copley says they should hold off.

Heuson says buying a home locks an investor into a geographic area, and it is an expensive investment to get into and out of. Closing fees take 5 percent of the value of a house off the table, while fees for most mutual funds, exchange-traded funds and target-date funds are fractions of a percent.

Tapping into a 401(k) account to pay for a house also means that a person is relying on the idea that the appreciation rate while they live in the house will be at least as high as the appreciation rate of the investments that they have in their 401(k), Heuson says. A typical 401(k) investment in the stock market has returned, on average, around 8 percent a year since 1920 -- much higher than 2015's performance -- but few housing markets in the U.S. can be relied on to return that high a percentage.

And if money is withdrawn from a 401(k), investors are assuming their real estate investment will make up for the financial penalties incurred.

Taking a Loan Against Your 401(k)

Another option, if an employer allows, is to secure a 401(k) loan, which would allow investors to dip into their retirement account without risking taxes or penalties. However, the money must be paid back, and the account would lose the advantage of compounding interest that makes 401(k)s so valuable.

Michael Wiginton, a financial adviser in Jasper, Alabama, says many people who borrow from their 401(k) accounts never pay themselves back and find themselves in a worse financial position than they were previously. Wiginton says people have 401(k) accounts because there are no loans for retirement. If you can't afford a property without dipping into your retirement account, rent elsewhere until you can, he suggests.

"Borrowing against one's 401(k) is almost never advisable," Wiginton says. "That's typically very poor advice, no matter how many so-called justifications you see promoting it."

But Barry Jenkins, a real estate agent for Better Homes and Gardens Real Estate's Native American Group in Virginia, says he would rather have his money in real estate than the stock market. He liquidated his 401(k) account to invest in real estate.

"I know I'm going to look out for my best interest more than a mortgage broker," says Jenkins, who owns more than 17 homes and bought his first as an investment property at age 18.

It is an idea that resonates with millennials, Jenkins says. They want to be in control of their finances, and they trust themselves more than they trust others, he says, adding that he regularly has millennial clients who choose to use their 401(k) money when purchasing a home.

Recognizing the advice of financial professionals, Jenkins acknowledges he is missing a financial opportunity by not contributing to a 401(k), but it's a sacrifice he's willing to make. Jenkins says he is increasing the number of investment properties that he owns, building his wealth in the process.

"I'm just doing so well with real estate," he says.

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