May 13 2009

Borrow from the future for your down payment?

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.

Check out his responses here and here.

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?

8 Responses to “Borrow from the future for your down payment?”

  1. In this economy, I think I’d keep saving for retirement AND for the house. Having learned from past mistakes I’d say have at least 10% down on a 15-year mortgage, closing costs and 10% more in savings for unexpected household repairs [every repair I’ve ever needed in the first year was NOT covered by the warranty with the house]. That 10% extra savings will also help buy lawnmowers, cabinet organizing things, or even that can’t-live-without paint. It will also replace the bathroom flooring when that leak your home inspector missed flares up or pays the exterminator for that unnoticed den of vermon in the attick. I’ve done house buying “on a wing and a prayer” and wouldn’t do it again. Renting can feel bad, but being “upside down” on a mortgage in a bad real estate market feels like death. You’ve got a great financial head on your shoulders so I know you will make a sensible choice. And, I agree–Dave Ramsey just plain rocks!

  2. Forgot: one added benefit of renting while you are young is you are much freer to up and move if that “perfect job” really does come your way….or the house you’ve always wanted to buy in your home town comes up for sale. Trying to sell a house right now is pretty tough!

  3. I would say that if you are saving the company match or a little higher that you should be fine. Like you said, you both are young and have time on your side. From my situation: we purchased a house with 5% down and now have two mortgages, the second to avoid paying PMI. I wish I could have bought the house with 20% down, so yes, I would sacrifice putting 15% in my retirement account and put the difference from company match to 15% in a separate savings for a down payment. I don’t know if that makes any sense. lol

  4. Hi Kacie,

    I agree with you on the potential to have that $7500 turn into something much larger.

    Personally if it were me, I would’ve postponed the retirement contributions and gone with a house. BUT that is only because I really, really enjoying having a yard, garden, etc. Each family needs to make their own choice.

    I do believe that if a person is commited to a frugal lifestyle, is happy with less of a “stuff” based life and is a disciplined spender and saver throughout their whole lives — then they will find out that they do not need nearly as much money to live on in retirement as most of the savings models indicated. In this case it might not be a bad idea to forgo retirement contributions for a couple of years if your heart is really set on having a house.

    Sorry, this is so long, but how about one more idea.

    Is there anything you and/or your husband could do to earn the extra money? I’ve always done this, and found it to be very helpful. That way I could still keep on saving and buy something I wanted too.

    Take Care,


  5. Unfortunately, Shane is no longer getting a company match. The company cut it to save money. Blah! We’re hopeful that they’ll reinstate it at some point.

  6. My blog is how I earn extra money, from advertisements and affiliate links. Our “free” time is pretty much consumed by our baby right now and I don’t think either of us have time to try to earn anything extra beyond that. Maybe on down the road though!

  7. I think Dave is spot on.

    Yes, you may be sacrificing to save up for a down payment – but most people aren’t even doing that OR saving for retirement – he knows you’re ahead of the game if you’re asking the question.

    Dave would rather you have that money in your emergency fund than have to pull it from your retirement account because your emergency fund is a penalty-free withdrawl!

    Besides a down payment – here are the things that have happened in the six years since we bought our home. Water heater replaced, air conditioning replaced, furnace replaced, rug replaced with tile in several rooms, probably three coats of paint all over the darn house (to cover the kid’s artwork that would not wash off lol) – most of those were emergencies where we had to scrimp and not pay a bill because we didn’t have an emergency fund back then.

    Good luck with your decision!

  8. I think it’s a terrible idea to borrow from your future.

    Think about it this way: You don’t know what the future hold. No matter how stable and predictable you think your life is. What if you put the retirement savings on hold, save up for a house and then, within the first few years, end up having to move? To a place with a MUCH higher cost of living? Then you’d once again have to decide whether to save or put your retirement savings on hold once again.

    A house is nice. I would love a house someday. But it’s not necessary, even with kids. It’s a luxury. Having money in your retirement fund is a necessity.

    Don’t forget that you can borrow from your 401(k) to help make a downpayment, too. So if you put the money into there, you’re covering both bases. (Just be sure that things are definitely stable, since there are strict rules about repayment, especially if you stop working for the company, whatever the reason.)

    The problem is, retirement is so far away that it is abstract to us. We think we can put it off. But we don’t realize the damage we’re doing. Even just a couple of years can be pretty huge.

    I remember reading an example in this book. (Obviously, right now, the market is unstable at best, but over time it will stabilize and even have more booms, if you look at historical data.) So:

    One woman starts contributing at age 22. She puts in $3,000 from age 22-32. She then stops and never puts in another dime.

    Her twin, however, starts later. She contributes from age 32-62. She also contributes $3,000 a year.

    Based on average market returns — again, not currently the case, but the market will, at some point, recover — the first twin will have around $200,000 MORE than her sister. Despite two decades’ less of contributions.

    Just something to think about when you consider putting off retirement funding for “a little while.”

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Hey! I'm Kacie, wife to Shane and mother to Jonathan (7), Vivienne (5) and Amelia (2) . I write about my family's finance: how we save money, improve our spending, and plan for the future.

I hope I can inspire and encourage you to improve your situation. See disclosure.

I'm adopting a much slower-paced posting schedule, and treating this as a hobby blog now.

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