I’m a huge fan of Dave Ramsey and his seven baby steps. For us renters, we have to modify the steps so we can build up a down payment for a house.
Renters should start saving for a down payment after all of their debts are paid off and after they have a full emergency fund.
In two instances on his web site, he has said that it would be ok for someone to temporarily postpone retirement savings if they’re committed to saving for a big down payment on a house. He says not to do this for longer than 18-24 months.
Is this reasonable advice?
Say you make $50,000 per year. If you were to contribute 15 percent of your income to retirement, that’s $7,500 per year. In 18 months, that’s $11,250 and in 24, that’s $15,000.
If you add that to a previous debt snowball or other savings, that indeed would be a pretty good down payment in most markets.
However, you have to weigh the costs of pausing your retirement contributions with the possible benefits of being in a house sooner.
That $7,500 annual contribution to your 401k could grow substantially by the time you hit retirement, depending on the markets and how many years you have until age 59.5. It could also lose all of its value.
Say that money can earn an 8 percent return in a Roth 401k (that’s what we have — we pay taxes on the money now instead of when we make a withdrawl in 35 years). Even after factoring in a 3.1% annual rate of inflation, that $7,500 could potentially grow to $28,000 in today’s dollars. Big deal!
Again, it’s hard to say what that money could grow to, but the possibilities are good for a decent return.
As such, we aren’t going to totally stop saving for retirement. But, we aren’t going to invest our full 15% right now. We’ll leave our contributions where they are for now, which is around 8 or 9 percent.
You see, we have 35 years until we can make a penalty-free withdrawl from our roth 401k. That’s a long time for compound interest to work its wonders.
And, we do think that we can scrape together a decent down payment in a year to a year and a half. Reducing our retirement contributions wouldn’t change our purchase date by more than a few months or so.
Especially for folks who have a company match on retirement contributions, I’d say always contribute enough to get that full match unless you can’t pay your bills or doing so would make getting out of debt extremely difficult.
But, if you wouldn’t be able to get a down payment without pausing or reducing retirement contributions, it might be an option worth exploring.
What do you think?