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You should read this if you’re thinking about how to make a down payment.
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If you’re trying to buy a home, you probably already know that coming up with the down payment on your property is one of the biggest challenges you’ll face. That’s because the majority of mortgage lenders require you to put at least 3% and ideally closer to 10% or 20% down on a property — and this means coming up with thousands of dollars.
When you’re eager to get into a property of your own, you may be tempted to look for funds from any sources that might be available to you. But, there’s one approach that finance expert Dave Ramsey said you should absolutely steer clear of.
Don’t get your home down payment from this source
If you have money in a retirement account, like a 401(k), and you’re struggling to come up with money for a home down payment, you may be tempted to just withdraw the money from your retirement plan. After all, it may seem like it makes little sense to have thousands of dollars just sitting in an account you probably won’t need for decades when you need a home now.
The reality, though, is that while you technically can take money out of your retirement plan for a home down payment, you really shouldn’t. In fact, Dave Ramsey has been adamant in insisting taking this approach would be a really bad financial choice.
“Making an early withdrawal is a horrible idea,” Ramsey said. “You’ll get hit with income taxes plus a 10% penalty. No thanks!”
Ramsey explained that while it may be “tempting to tap into that pile of cash in your retirement account,” the cost to you both right now and in the future would be far too great.
Why tapping your 401(k) for a home down payment is a bad idea
Taking money out of your 401(k) is not the right approach for exactly the reasons Ramsey outlines.
Your 401(k) (and other retirement plans, like IRA accounts) is tax advantaged. You get special tax breaks for contributing to these accounts because the government wants to encourage you to save for retirement. The catch is, in most cases, you’ll get hit with a big tax bill if you take money out of them before you’re actually retirement age.
You not only have to pay taxes on the money withdrawn from your 401(k) at your ordinary income tax rate, but you also have to pay a 10% penalty. So you don’t end up with as much money as you expected, and the IRS takes a huge cut.
Ramsey also warns that a 401(k) withdrawal could cost you a fortune in lost compound growth because the money you take out wouldn’t continue to earn returns that could be reinvested.
You don’t want to face these undesirable consequences of raiding your retirement accounts to fund your home purchase, so don’t even consider this idea. Instead, keep saving or look for other solutions like picking up some side work. This will help your down payment balance grow bigger ASAP so you can get into a home soon without putting your future self at risk of struggling in retirement.
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