Owning your house free and clear is a goal all homeowners look forward to. Years, or most likely decades, of monthly mortgage payments is a burden most of us can’t wait to leave behind. With a mortgage typically consuming as much as one-third or more of a household’s income, writing that last check will be like a huge weight being lifted from your shoulders.

So what if you could make that monthly nut to crack magically disappear? That was the possibility facing a recent caller named Reuben to financial guru Dave Ramsey’s radio show.

Reuben told Ramsey he is looking to buy a house and has half the money for the purchase price saved up. What he wanted to know was, should he withdraw all the money from his wife’s 401(k) retirement plan to make up the difference and that way own his home outright?

24/7 Wall St. Insights:

• Owning a house free and clear is a goal most homeowners have, and withdrawing money from a 401(k) plan to achieve it is a tempting opportunity.
• Retirement plan withdrawals come with hidden risks, however, including taxes and penalties that make it a risky option.
• Financial guru Dave Ramsey explains a better path to take for owning a home mortgage-free.
• Also: Take this quiz to see if you’re on track to retire ^(Sponsored)

Financing the American Dream

Owning a home is part and parcel of the American Dream. It is an asset that (usually) appreciates in value and it gives you a sense of permanence, even if the bank holds the title. Yet it is becoming harder for the average person to participate in this storied way of life for millions.

The average sale price of a home in the U.S. is $500,000 as of the end of September, though the median price is marginally more affordable at $426,000, according to the U.S. Census Bureau. That’s 63% more than the median price just 10 years ago ($261,500) and more than double the price 20 years ago ($211,000). At that rate of inflation, the price of a new house could cost over $601,000 in another 10 years.

And even though mortgage rates were supposed to decline as the Federal Reserve began cutting interest rates, that hasn’t happened. A 30-year fixed rate mortgage now goes for 6.9%, an 800 basis points increase from where they stood in mid-September when the Fed made its first cut.

Hidden risks of 401(k) withdrawals

Withdrawing funds from a 401(k) plan to buy a house certainly sounds like a smart move. As inflation chugs higher, getting a house now before prices and rates move up — and then never having to worry about a mortgage payment again — seems like a savvy play.

Yet Ramsey cautions that your withdrawal will be subject to an automatic 10% penalty for taking out money before 59-1/2 years old and the money received will be counted towards your income. That means if you’re in a 25% tax bracket right now, you’re going to be socked with a huge tax bill on that 401(k) cash.

Or as Ramsey put it, “So what you kinda just accidentally asked me was, Dave, I want to borrow money at 35% interest to have a paid-for house. That, of course, would be ridiculous, wouldn’t it?”

Reuben could take a loan on his 401(k), since he wouldn’t pay taxes or penalties on the withdrawal, but even that has limitations. 

Depending upon what your plan allows, you could borrow half of your vested account balance, or $50,000, whichever is less, though you would have to pay the money back, plus interest. While you are paying yourself at that point, you’ve lost the time and compounding effect of the money in the account and you would still have a mortgage payment. You may have just made your problem worse.

Key takeaways

Consider your 401(k) sacrosanct and don’t touch the money in the account. Rather, look for other ways to raise money for a down payment.

Reuben also had two cars with notes on them, one as much as $30,000. Ramsey advised selling that car because he has too much money tied up in a depreciating asset. He should use the proceeds to pay off the other one and buy a $10,000 car instead. He said Reuben should apply the remaining proceeds towards the down payment. He could then put the house on a 15-year fixed rate mortgage. With zero debt at that point, he should work on paying down the house.

While the path of least resistance may seem best, it could end up being the more expensive option that hurts your overall finances.

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