- The Washington Times - Wednesday, May 23, 2007

Q:We are in the early stages of the home-buying process. We don’t have a lot of liquid

savings, but I have more than $200,000 in my 401(k) retirement account. I have been told by my employer that I can borrow up to $100,000 against the account for a 20 percent down payment at only a 6 percent interest rate.

My wife says that the 401(k) account is our nest egg and thinks we should obtain a 100 percent mortgage instead. We looked at that option, but the mortgage rates were

a lot higher.

What are the disadvantages of borrowing against my 401(k) account?

A: As far as I know, the biggest disadvantage of a 401(k) loan to be used as a down payment for a home purchase is that the interest paid is not tax deductible. However, as you have discovered in your due diligence, a 100 percent mortgage will carry a much higher interest rate than an 80 percent loan.

From the lender’s point of view, an 80 percent loan secured against the property carries a lower risk of default because the value of the collateral is far higher than the loan amount. This is why the interest rates on 100 percent financing scenarios will be significantly higher.

From the buyer’s point of view, taking out an 80 percent mortgage and a 20 percent loan secured against a retirement account is still 100 percent financing. You are merely borrowing the money using two different pieces of collateral.

While your wife’s assertion that the 401(k) is your nest egg may be valid, it’s irrelevant. It’s important to look at your financial picture as a whole.

If you are buying a $500,000 house, for example, and you take out a $400,000 mortgage and $100,000 401(k) loan, your total debt is equal to $500,000, which will eventually be paid off.

In exchange for the debt, your assets increased by $500,000 because you own the house. Your net worth doesn’t change because your $500,000 increase in assets are offset by the same amount of debt.

If you decided to liquidate $100,000 of your 401(k) account and used the cash for the down payment, your overall debt would total only $400,000.

You would have $100,000 worth of equity in your home, but the value of your 401(k) account would be $100,000 less.

Again, your overall net worth doesn’t change.

If you have ruled out liquidating part of your 401(k) account, the only alternative is 100 percent financing. It appears that splitting the financing in two parts, an 80 percent first trust secured against the property and a 20 percent loan secured against your retirement account, is the least expensive way to borrow the money.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).

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