Loan from your 403(b): Part One New Home Purchase and Down Payment

Congratulations on taking the step to purchase your first home. This is an exciting and emotional moment! A house is often the largest purchase one will ever make. As a result, decisions surrounding the purchase should be considered with as many facts as possible, not emotion.

I want to talk about the down payment. My concern is, Mortgage or New Home Consultant are often quick to suggest taking a loan or withdrawal from against your employer-sponsored retirement plan (403(b), 401(k)) to fund your down payment. While this often is an option through your employer; just because you can, doesn’t mean you should.

As a CERTIFIED FINANCIAL PLANNER™ (CFP®), I have a fiduciary responsibility to put the investors best interest before my own. Too often, Mortgage or New Home Consultant encourage or even recommend liquidating retirement accounts for a home purchase. Often, they are paid on commission; meaning they benefit 100% from your purchase, the bigger the better, regardless of how it is paid for and if it is in the best interest of your financial well-being.

Your employer-sponsored retirement account may be your largest savings account. If your employer allows for loans, there is no credit check. Not only is it the largest balance, it has now become the easiest to obtain.

The questions I am asked by investors are, “What is my interest rate?” and “Can I take it all?” The answer deserves a deeper explanation.

You may be allowed to take a loan of up to 50% of your employer-sponsored retirement account balance. You are never allowed to take 100%, as the remainder is considered collateral for the loan.

Interest rate (current rate at Empower as of 7/2019): 7.5%
Loan origination fee: $50
Quarterly loan fee: $6.25

Everything sounds pretty good at this point! Many investors may think, “This is simple. The interest rate is higher than at the bank, but I don’t have to go through a credit check, this sounds great!”

Please consider the following:

When you take a loan from your employer-sponsored retirement plan, you will be cashing-in shares of this investment which you bought through your payroll deductions and you will sacrifice future potential earnings on those shares.
When you repay the loan, you will buy new shares at the current market price.
The “real cost” of the loan may be substantially higher than the stated interest rate.

Example: You invested in your employer-sponsored retirement account though payroll deductions during 2008 and 2009 (a low point for the US Stock Market) to present. The Dow Jones Industrial Average (DJIA) closed on 3/9/2009 at approximately 6,507. On 3/8/2019, almost 10 year later, the DJIA closed at 25,450[1]

To establish a loan, you will sell shares of the investment you own, to fund the loan.
Though your loan repayment, you will purchase shares of the investment at the stock market’s current value.
Had you been investing in this account and take a loan, the loan would have cost you approximately 300% in growth, plus the 7.5% stated interest rate.

Would anyone who is looking out for your best financial interest think this is a wise decision?

In general, defaults on employer-sponsored plan loans are higher than if a loan it taken at a bank. If you default on this loan, there are two consequences:

The distribution becomes a taxable event and you will be responsible for penalties and taxes to the IRA.

You are not allowed to take a loan from the plan in the future.

I encourage you to research this topic of loans and early distributors of retirement account on your own, with as little emption as possible. I often hear of frustration and regret once a person is a few years into the loan.

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Content in this material is for general information and is not intended to provide specific advice or recommendations for any individual. All investing involves risk, including loss of principal. No strategy assures success or protects against loss.

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[1] Source: www.fedprimerate.com/dow-jones-industrial-average-history-djia.htm

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