Financing in Gladwyne>Question Details

Wondering Wh…, Home Buyer in Gladwyne, PA

I will be purchasing a home soon. Is it best to use a 401k loan for the down payment or to reduce my credit card debt before applying for mortgage?

Asked by Wondering What Is Right?, Gladwyne, PA Thu Jun 30, 2011

The home price is $250K.
My 401(k) loan is $20K.
My credit card debt is $40K.
I have $40K saved for the down payment.

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Answers

8
There are many factors in your question.

1. First, If you have $40k saved and still need more, then it would appear you are trying to put 20% down ($50k). This will save you from having to pay PMI (private mortgage insurance).

2. Second, a 401k loan is not always a bad idea, as you are paying yourself interest and as long as you pay it back, you have no tax implications. One note of caution, I took a 401k loan for dental work and was laid off before I could pay it all back, so it was unable to be included in my rollover to my new IRA and I had to pay taxes on the amount of the outstanding loan. So the lesson to be learned is... to only take a 401k if you are sure you will not be leaving your employer (either voluntarily or involuntarily) until the end of the term of your loan repayment.

3. Third, as far as paying down your credit card debt, I imagine it will be a higher interest rate than your 401k, so as long as there are no fees to your 401k loan, it could make sense to use the 401k loan to pay down your credit card debt (in part or in full). Either way, you will still have a monthly payment to budget for (whether credit card or 401k).

4. Lastly, it could make sense financially to put 5, 10 or 15% down (instead of 20%) and pay the PMI for a time. You could use the excess funds to pay down the higher-interest credit cards and lower or wipe out entirely that monthly payment. As you have extra money and pay down your mortgage, if you reach 20% paid in prior to the end of the PMI payment period, you can stop paying PMI and may actually get a refund of some PMI paid in.

You would really have to speak to an agent or a mortgage rep to run all these scenarios in Excel to see which one made the most sense. Hope this helps and let me know if you need anything else. Good luck!
Web Reference: http://www.FamousEric.com
2 votes Thank Flag Link Thu Jun 30, 2011
You may want to consider doing neither. Instead, assuming you qualify, reduce the downpayment on the new home to the minimum (3% to 5%), and using the rest to pay dow your credit cards. There are a lot of reasons not to take a 401k loan, and converting higher rate credit cards to low rate, tax deductible mortgage interest will save you money on your taxes.
1 vote Thank Flag Link Fri Jul 1, 2011
I would strongly encourage you to speak with a mortgage banker and allow he or she to review your overall financial information before you pay down any debt. An experienced banker, while not a financial planner, should be able to dispense good advise as to whether, or not a 401k loan is a wise choice. Generally speaking, a 401k loan is not a good idea, however as previously mentioned, if it allows you to avoid costly mortgage insurance, then it might make sense.
1 vote Thank Flag Link Fri Jul 1, 2011
Hello Wondering.

Before we look at the financial implications of pying off one debt or another, we would fhave to see whether one course of action impacts your loan qualification. If you have $40,000 in credit card deb that may impact qualification more than having a 401k loan. Even if you have deferred interest, the lender is still going to access a minimum payment on the credit cards of 2% ($800 per month).

If you qualify both ways, we then have to weight the costs of each course of action. These are some basic assumptions

1. The 401k loan is no cost to you as you are paying yourself interest.
2. The credit cards will cost you at least 10% interest or higher over the course of the loan
3. The cost of a 10% down loan is only about 0.375% in rate or a one time payment of $3150.
4. $40,000 of credit cards at 10% will cost you $4000 in interest PER YEAR.

I would pay off the cards and get a 10% down loan.
There are always more varianbls to consider as everyone's situation is different. I'd be happy to sit down with you and discuss your situation.

Best Regards,
Alan Openshaw
Cornerstone Lending Inc
Southampton Pa 18966
215 953 0800
cell 267 992 7276
VOTED BEST IN BUCKS 2010
1 vote Thank Flag Link Fri Jul 1, 2011
Awesome answer Eric - thumbs up for you.

As far as the info on a mortgage - with less than 20% down and conventional financing, Eric is right you'll likely have to pay a form of PMI (unless you can find a 2nd mortgage going over 80% Combined Loan To Value/CLTV), however you have some options when you pay PMI - the traditional monthly amount, an upfront amount, or a higher-interest-rate-in-trade-of-PMI. Depending on how soon you'd be close to paying off the traditional monthly amount when you start usually determines which option would be best for lowest amount of PMI over the life of the loan.

Is the $40k in credit card debt at a high interest rate? Even if it's not, you may want to take some of the $40k cash you have for the down payment and concentrate on knocking that out before buying a home.

I hate credit card debt personally, and with that much on the books are you paying a pretty hefty finance charge each month? Compound interest is is good in investment vehicles, not on debt. If you are just making the minimums, and you do need to buy a home sooner rather than later, keep in mind the interest you'd save each month by paying off the compounding interest credit card debt would be more than the extra interest on the higher mortgage amount you are financing, assuming the payments are equal (meaning you are not goaded into making the lower monthly payment on the 30-year mortgage term, but you instead make the "same old payment" you had to make on the credit card debt and just applying them to the mortgage - paying off the mortgage much quicker).
1 vote Thank Flag Link Thu Jun 30, 2011
Erik's answer (first one to reply) is excellent! I personally would borrow from 401k to pay down higher interest debt. And I would pay PMI to put down only 5-10%.
0 votes Thank Flag Link Thu Jul 28, 2011
All of the Mortgage Brokers answers below have alot of great information. Not sure of your salary but paying off the debt of your credit cards is essential(discipline to keep these low afterwards or cancelling several as well). FHA financing may be a great option if you can afford the payment. Your Debt to Income ratio will improve if you pay of the plastic/cancel some, etc. Best of Luck
0 votes Thank Flag Link Thu Jul 28, 2011
All of these answers are great but assuming too much. What you are approved for, rates on 401, credit cards and what you want to accomplish are the missing items. Without those many here can be right or wrong but purely coincidentally. There are financing programs that you could qualify for that give you great rates with little down so you can pay off the higher interest rates on credit cards and depending on your payments on these (in order to pay them off in your lifetime) your overall cashflow might be better thinking in another direction. Many Gladwyne real estate clients have come to me and with my finance team we have found with a little more information we were able to surprise them with their overall financial fitness when buying their home. Give us a little more information and a few of us (many have really great answers) could give you some better options more in tune with YOUR specifics. Good Luck!
0 votes Thank Flag Link Thu Jul 28, 2011
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