The Journey Beyond the Buy
Navigating Your Finances After You Have the Keys
by Alacias Enger
Therese is a single, thirty-seven-year-old, New York City teacher. Having always wanted to work with children, Therese adores her job and the many wonderful benefits it provides her. Among those benefits, she has access to a high-quality health insurance plan, which she couples with a co-pay program that helps her with the costs of her medications. She also has a 401(k) in addition to her pension.
Teaching remotely during much of the COVID-19 pandemic made Therese realize that she needed more space than her tiny, one-bedroom apartment provided. So, when she started looking to make her first home purchase, she eventually settled on a two-bedroom condo just outside of the city. To facilitate this purchase, Therese utilized a combination of resources. She had managed to save $20,000 toward a down payment and took out a small 401(k)-loan to secure enough funds to cover a 10% down payment and closing costs. At the end of the transaction, Therese was left with a few thousand dollars in cash and a 401(k)-loan outstanding.
With the soaring cost of home prices, more Americans than ever are turning to 401(k) loans as a source of cash to put toward a home purchase. While this can provide much needed assistance, it is important to understand that taking a loan against retirement isn’t ideal and comes with some distinct disadvantages. The first disadvantage is the loss of time in the market. Compounding is one of the most powerful retirement building tools at our disposal and removing funds (even temporarily) is a major disruptor. Moreover, people become attracted by the offer of low monthly repayment options that stretch over a matter of years, further disrupting the growth of their nest egg. Also, people repay 401(k) loans using after-tax dollars, which slows the progress toward repayment. Another important consideration is that of job stability. If you become separated from employment while there is an outstanding 401(k) loan, the full balance of the loan becomes due within a specific time frame; otherwise, it becomes a distribution which can trigger taxes and penalties. Fortunately, Therese is a tenured teacher, and her position is fairly secure. That being said, she should still be looking to repay this loan as fast as possible in order to shorten the amount of time her money spends out of the market.
Since Therese purchased her home with 10% down rather than the traditional 20%, she was required to get Private Mortgage Insurance or PMI. PMI is a type of insurance that helps the lender recover funds in the event that the borrower fails to repay the loan. In other words, homeowners that have PMI are paying for an insurance policy that protects their lender from them. PMI doesn’t actually protect the homeowner at all. Plus, it’s expensive. There are a number of factors involved in determining the cost of PMI, but typically, you can expect to pay somewhere in the range of $40-$80 monthly per $100,000 borrowed. This adds up very quickly, especially for insurance that is only intended to protect the lender. The good news is that PMI is temporary. The bank is required to drop PMI under certain conditions, and it is possible for homeowners to achieve this sooner. Once a homeowner has achieved an 80% LTV (loan-to-value, meaning a homeowner pays down the mortgage, the value increases, or both), PMI can be dropped, but likely the homeowner will have to officially request it. This is where it pays to pay attention. It is imperative that Therese carefully monitor the amount of equity she has in her home so that she doesn’t end up paying PMI any longer than necessary.
Therese should also turn her attention toward beefing up her emergency fund. Moving is already a major expense and doing so in one of America’s most expensive cities takes an extra toll on any savings account. Therese still has a few thousand dollars in savings after her home purchase and move, but that isn’t nearly enough to stave off a potential disaster. Without a properly funded emergency fund, any home repair, loss of income, or medical emergency could create a huge financial setback. An emergency fund can insulate her from having that occur. Financial expert recommendations vary but starting off by building toward three to six months of expenses and then potentially increasing from there would be a wise plan.
Therese has come so far, achieving her goal of home ownership. By taking these next steps, she can save some money and further secure her financial future.
Alacias Enger is a performing artist, writer, and educator. She lives with her partner in New York City, and is the founder of blogs “Sense with Cents” and “Travel Cents.” Follow her on Twitter @sense_w_cents.