Real Estate Investing
Home Buying Tips
September 19 2019 - 5 Tips For First Time Home Buyers Aiming To Slash Their Down Payment By Investors Business Daily
Are you a first time home buyer shopping for a home, but cash strapped? Are you afraid you can't come up with money to make the down payment and closing costs?
Many home buyers get over that hurdle by tapping their retirement accounts. That gives them cash for their down payment and closing costs. But in the long run it's a dubious strategy that pawns part of their golden years by cutting the size of their retirement savings.
Alarmed financial advisors strongly recommend alternative strategies for newcomers to the housing game like a first time home buyer.
All of these alternatives steer you away from the harmful practice of cannibalizing your retirement savings.
First Time Home Buyer Down Payment Strategies
A first time home buyer or a veteran house hunter, for that matter should use one or more of these five alternative, innovative strategies. Some lower your down payment and closing costs. Some of these steps can lower your interest rate. In turn, that can cut your long-term mortgage costs. It can also make you eligible for state and local programs that can help you pay your down payment and closing costs.
These alternative steps can save you money potentially as much as or more than you'd take from your retirement account.
Equally important, you can do any of these without tapping your retirement savings. They leave your retirement savings alone, able to compound and grow in your tax-sheltered account.
Look into home buyers' local assistance programs in your area. You may qualify for enough money to eliminate the need to take money from your retirement account, says Christian Patterson, a wealth advisor in Exencial Wealth Advisors' Frisco, Texas, office. Texas, for example, offers zero-interest loans buyers can use for a down payment and closing costs. The loan can be up to 5% of the purchase price, whose maximum varies by metropolitan area. Your eligibility depends on factors such as income and credit score.
Figure out how much you can afford. Use an online calculator. "Map out your budget using net numbers, not gross numbers (before taxes and deductions)," said Dana Anspach, CEO of Sensible Money in Scottsdale, Ariz. First time homebuyer or veteran, one popular rule of thumb says you should limit housing expenses to 28% of your household's gross income.
Check your credit report and score. Do it early enough to give you time to correct any errors and improve your credit score.
More Steps For A First Time Home Buyer
Reduce use of credit. "Avoid taking out new lines of credit during the homebuying process any inquiry on your credit report can temporarily decrease your credit score," Anspach said. "Additionally, try not to use your credit cards during the process." Both steps help you avoid surprises and hassles that could hurt your score and raise your mortgage interest rate.
Explore programs such as FHA loans. Federal Housing Administration loans customarily require smaller down payments, often around 3.5%. But they often charge higher interest and are not available for all types of properties. Their added paperwork may make you a less desirable customer to a seller too. Also, you may have to use and pay for private mortgage insurance (PMI) with an FHA loan, Anspach says.
Who Taps Their Retirement Account For A Down Payment?
Eating into your retirement accounts for a down payment and closing costs on a house is a fairly common practice.
Millennials are the leading offenders in this area. To fund a down payment, 13% of first time home buyer millennials ate into their retirement savings. Eight percent of Gen Xers tapped retirement accounts for that. So have 7% of boomers, according to a new survey by Bankrate.com.
Advisors explain why raiding your retirement account is bad. Basically, it is very costly especially for your retirement.
First Time Home Buyer Dos And Don'ts
Dan Griffith, senior vice president, director of wealth strategy at Huntington National Bank in Columbus, Ohio, gives a thumbs-down to raiding your retirement savings to buy a home. That goes whether you're a first time home buyer or not.
"Using retirement funds to fund a down payment virtually never makes sense," Griffith said.
Looking at the early withdrawal penalty as well as federal and state taxes in the top brackets, Griffith said, "With taxes and penalties, a direct distribution from a retirement account could mean that every $1 of house that you buy actually costs $1.50."
First Time Home Buyer Risks Losing Compound Interest
Worst of all, you deprive yourself of compound earnings growth on that money while it thrives inside a tax-sheltered retirement account for years, maybe decades, Griffith says. A five-figure withdrawal today to fund your down payment and closing costs, for example, can cost you six figures in decades of lost compound growth by the time you retire, he adds.
Cannibalizing Retirement Account Not Necessary
Tim Sullivan, CEO of Strategic Wealth Advisors Group, in Shelby Township, Mich., says an outright withdrawal from retirement savings is often unnecessary.
Instead, consider borrowing from accounts that permit it, he says, or taking a special withdrawal that's exempt from early withdrawal penalty. Most ordinary withdrawals and loans are governed by different tax rules.
"If it's a 401(k), you can borrow against it and then pay it back," Sullivan said. "If it is a Roth IRA or traditional IRA and you are a first time homeowner, you may qualify to (withdraw) up to $10,000 penalty free. You would still have to pay the taxes on the traditional IRA. As long as you held the Roth for five years, no taxes would have to be paid."
Early Withdrawal Penalty May Apply
Remember, you usually expose yourself to a 10% early withdrawal penalty when you make a withdrawal which the green eyeshade crowd often calls a distribution from a qualified retirement account before you are 59-1/2 years old, unless you qualify for an exemption.
If you do borrow from a 401(k) account, you must pay interest on the loan. And the loan must be repaid by a set deadline. That's often five years.
First Time Home Buyer Could Lose His Company Match
There are additional reasons not to take money from a retirement account for a down payment on a house.
For one, some plans do not allow members to contribute to their accounts while they have a loan outstanding.
For another, if your employer offers matching contributions, you won't get any while you aren't contributing to your account.
If it takes five years for you to repay your loan, that means you could lose out on five years of contributions and company matches. That's potentially a lot of lost money that you can never recoup. And you lose all of the potential earnings and compounding on that money, too.
Is A 401(k) Withdrawal A Trap?
And don't overlook the strategic risk. Are funds from your retirement account putting you into a home that you can't reasonably afford? Watch out, says Jean Wilczynski, senior wealth advisor at Exencial Wealth Advisors' Old Lyme, Conn., office.
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