Financial Experts - trade 401k for condo?
 

I'm considering buying a vacation condo. To do this I will have to cash out my 401k to have a down payment and pay off credit card bills which i could never afford with a mortgage. I'm thinking I will roll the cost of the credit card debt into the mortgage and then make a down payment with the 401k money. This would mean I could make a +20% deposit and avoid PMI. My 401k has made no money in 5 years, however, we know what the real estate market has done. If only I knew then what I know now. It really sucks. So I am thinking doing this isn't so crazy. The condo is in a vacation area but it is not on a body of water and it is still cheap. I can actually afford it. Next year, maybe not. I'm very tempted to do this. One and all are welcome to chime in.

Cashing in your 401K usually is a last resort kind of thing because ordinarily you will pay a penalty on the money cashed out and you will owe tax on that money and that money can never appreciate for you. But, you are young and you can build back up that 401K over time. Usually, the better solution is to borrow against the 401K if you can.

I would sit down and on one side of a sheet of paper write down the expenses involved such as the penalties and taxes owed on the cash out, the loss of appreciation (which can be lessened with a greater % of payment in the future), etc. In the other column, write down the savings such as mtg. interest deduction, interest paid on credit cards over time, etc., conservative appreciation of the real estate should you sell in, say, three years. That will give you a greater perspective of the actual costs involved here.

As Jason mentioned, there are stiff penalties for taking money out of your 401k. (I believe between the withdrawal penalty and the taxes, you might pay up 20% or 30%?) If you can borrow the money and pay it back, that's always better. And any interest you pay is being paid back to yourself.

A word of warning, though. I'm not sure if your 401k is from your current job or not. I have a 401k where I work. I took a rather large loan to make the down payment on our current house. I have 15 years to pay it back, and the payments are automatically withdrawn from my paycheck. However, if I pay it back early, it's an all or nothing deal. So I can't just make "extra payments" to bring the principal down. And if I leave my job, I have to pay back the balance of the loan within 90 days, or pay the withdrawal penalty and taxes. So unless I can come up with the whole amount of the loan, I'm either stuck here for 15 years (I'll never make it that long!), or I'm stuck with a huge tax bill. I'm not sure if this is a company rule, or a tax law. So my advice is whether you take a loan from your account, or a withdrawal, be sure you know what the rules are as far as taxes, penalties, etc. Real estate definitely can be a good investment, but be careful not to get in over your head because of a huge tax bill on a 401k loan or withdrawal.

Yeah, I factored the taxes and penalty in my calculation. Tax = 20% and penalty = 10%. Right now I have no assets except for the 401k. It would be nice to own something tangible. Also, because of things you stated above, I do not want to take a loan out of it.

Jason, I hadn't even thought of the tax write off, I will have to see what that is.

On edit: Here is a good article explaining this deduction: http://www.alllaw.com/articles/tax/article3.asp