Home Renovation: Use 1 Month Buffer, or 401K Loan?

My wife and I are new homeowners.  We are doing some renovations on the house before we move in.  

Hey there!  I'm looking for your perspective on something.  I'm a new homeowner and I'm in the process of renovating my home.  Most of the stuff we are doing are things that would need to be done before we move in (i.e. floors, electrical).  

In my case, in order to get these items done I am exploring taking a loan from my 401K.  Of course we were hoping to have the money for all of these items saved in advance, but some of the items are just going to be much easier to do before we move in.

My wife and I have a $20K House Emergency Fund, and 1 Month Buffer as well.  

I don't want to touch the Emergency Fund since some of the items in the house are old.   That leaves me with the question of: Should I use my 1 month buffer, or 401K Loan for the renovation?

I can't imagine life without my 1 month buffer, so I'm leaning towards my 401K Loan.  I also know that I can work to rebuild the buffer as well. 

If we borrow from the 401K we would prioritize a very quick payback.  The money borrowed is taken from my paycheck biweekly and paid back with 3.25% interest (which is slightly better than the rate of return on my 401K this year).  

What do you guys think?  

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  • A 401(k) loan comes with a lot of risk. If you quit, are laid off, or are fired, the full amount of the loan comes due within 30 days usually. And if you can't pay it back, it is treated as an early withdrawal in terms of taxes and penalties.

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      • jestarr
      • jestarr
      • 1 mth ago
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      jenmas Thanks.  I'd be able to pay back if I left the company using direct deposit, but your points are well taken.  Thank you!

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    • WordTenor
    • I have the honor to be your obedient servant
    • WordTenor
    • 1 mth ago
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    I’d pull from the emergency fund before I’d use either of the other two sources. But I would likely just not do the renos. However, I am very handy so working on a house I already live in is not a major concern for me. 
     

    If the renos were truly nonnegotiable, I’d use the EF and build it back aggressively after I took occupancy of the house. 

    Like 4
      • WordTenor
      • I have the honor to be your obedient servant
      • WordTenor
      • 1 mth ago
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      One additional thought: if you are truly a new homeowner, don’t overestimate what you can’t live with. I had a HUGE punch list when I bought my first house three years ago. They were things that I was definitely going to do RIGHT. AWAY. Three years later, I’ve done...about half of them. And I heard this advice before I bought my house, and thought “That advice doesn’t apply to *me.* I will do these things.” Nope. It applied to me!

      Like 5
      • jestarr
      • jestarr
      • 1 mth ago
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      WordTenor Appreciate your words!  My wife and I are definitely trying to balance our need vs. nice to have.  Unfortunately the prior owner was an older couple that neglected the house.  We are doing things like flooring (which is much easier to do when we aren't in the house with our young kids), lighting in the rooms, and replacing old washer/dryers.  

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  • There's no difference between using the emergency fund and using the one month buffer beyond the fact that using the buffer just makes budgeting slightly more difficult. Therefor, I'd use the emergency fund. I absolutely would not use the 401k loan.

    FYI, that 3.25% interest rate isn't as good as you think it is. You are paying that interest with after-tax money you already have, so it's not a return, and of course when you withdraw it, you'll be paying taxes on it again at your marginal rate. If you are in the 22% tax bracket on contribution and withdrawal, you are paying closer to 5% to put that money in the 401k (and a little over 4% in the 12% bracket).

    Like 3
      • jestarr
      • jestarr
      • 1 mth ago
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      nolesrule In my case it would be a loan, not a withdrawal.  It would get paid back on a bi-weekly basis from my paycheck.  Your point about it being paid with after tax dollars is totally well taken. 

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      • jenmas
      • jenmas
      • 1 mth ago
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      jestarr he meant when you withdraw it in retirement - so it's funded with post tax dollars and you still have to pay tax when you take it out in the future.

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      • nolesrule
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      • nolesrule
      • 1 mth ago
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      jestarr My calculation was purely for taxes on the post-tax interest being paid. I was not making any calculation on the loan repayment itself.

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  • How many of these things are absolute necessities (like the hvac not working correctly and you live in a cold climate) vs thing that would be really, really nice to have? Getting VERY real about what has to be done vs what will be nice to have is important. That's why I still have a 1960's pink bathroom and an ugly 70's yellow kitchen. They will be VERY nice when they are done, but both are serviceable (UGLY but functional...) right now, and way less important than the HVAC and washer dryer replacements that already happened, and the impending boiler/hot water heater replacement that is coming....

    It is much easier to do things before you move in, of course, but that also means that you are likely paying for somewhere to live and "finishing" the house - which means double bills. So don't forget to factor that into consideration as well.

    The other option you might want to explore if you haven't finalized your mortgage is rolling those renovations into the mortgage.

    If that isn't an option (like everything is already a done deal) then the other thing you might want to look into is what kind of financing you can get through various companies for the work. Many places offer zero interest payment plans for different types of projects, and if you find a good company that can do the majority of the work, they may be willing to offer discounts or payment plans for bundling things together.

    Best of luck, a new house is so much fun, especially when you do get to do fun things to it to make it yours!

    Like 1
      • jestarr
      • jestarr
      • 1 mth ago
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      farfromtheusual Everything is said and done with the mortgage.  

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    • Superbone
    • YNAB convert since 2008
    • Superbone
    • 1 mth ago
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    I agree with everybody here. Avoid the 401k loan. You already have the funds you need. Aggressively pay them back afterward. I'd use the EF before the buffer. Not sure why you're taking it out of the equation.

    I did take out a 401k loan about 6 years ago so that I could get rid of a second mortgage but I didn't have the cash reserves at the time like you do. I hated it. I paid it back within a couple months. If you don't have to, don't do it. Think of it this way, if you used your EF and then had further emergencies, then you could think about the 401k loan. Use it only as a last resort.

    Like 3
      • jestarr
      • jestarr
      • 1 mth ago
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      Superbone Your response was super, super helpful.  I never thought of it this way.  I have the cash reserves, and I can always use the 401K in an emergency if needed.  I can just think of the EF the same way I did with the 401K payback.  

      Like 2
  • The responses in this thread are the reason that I asked the question to this community in the first place.  I anticipated getting a good response, and got tons!  I am going to just use my cash on hand and aggressively pay them back.  

    Like 5
    • Scott
    • In the beginning the budget was created. This has made many people very angry and has widely been regarded as a bad move
    • Scottgoeshiking
    • 1 mth ago
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    As someone heading down the homeownership path, would a loan for the repairs be a viable option?

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      • nolesrule
      • YNAB4 Evangelist
      • nolesrule
      • 1 mth ago
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      Scott You mean like a personal loan? I wouldn't if I had the money. I also wouldn't buy the house if I didn't have the money up front for those expenses.

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      • Scott
      • In the beginning the budget was created. This has made many people very angry and has widely been regarded as a bad move
      • Scottgoeshiking
      • 1 mth ago
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      nolesrule yup agreed on that. Just thinking of other options. I like the idea of rolling time-of-sale repairs into the mortgage if possible.

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      • nolesrule
      • YNAB4 Evangelist
      • nolesrule
      • 1 mth ago
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      Scott How is that going to work exactly? A purchase mortgage is not a cash out refinance. You are unlikely to be able to roll the costs in with the grace of the mortgage company. Additionally you'll be paying interest on those costs.

      The only way I see the lender going for it is if you can put down 20% plus the costs to maintain the LTV (yes, there are lenders that might allow you to roll in closing costs, but I've never seen them roll in post-purchase repair costs), but then you might as well just pay the costs rather than rolling them into the loan since you already have the cash.

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      • Scott
      • In the beginning the budget was created. This has made many people very angry and has widely been regarded as a bad move
      • Scottgoeshiking
      • 1 mth ago
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      nolesrule 

      Not sure, just saw that farfromtheusual mentioned it. I figure the repairs would be part of the sale price negotiation.

      farfromtheusual said:
      The other option you might want to explore if you haven't finalized your mortgage is rolling those renovations into the mortgage.
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  • Avoid the 401k loan for all the reasons mentioned.  In a dire emergency the option would still be there later if you need it.

    Like 1
  • I guess I'm the odd-person out. I don't see much issue taking the 401k loan assuming you will spend regardless. It's a question of the relative return. If you use the EF, you get whatever gains OR LOSSES you get in the 401k. If you use the 401k, you get the guaranteed 1.5% (current savings rates) by keeping the EF in a high-yield savings account.

    I don't see how the tax is much of a consideration with the 401k loan -- you are using after-tax dollars in either case (either to pay for stuff from the EF or repay the 401k). Certainly at retirement you pay tax on distributions, but you will do that anyway.

    Yes, you are not getting the "full" value on the loan "interest" as you would if you contributed that pre-tax. So you're losing 22ish% of 3.5% of the loan amount ($154 on a $20k loan), reducing the "guaranteed" return.

    The real issue as I see it is whether you think the 401k will go up appreciably before repayment. This is much the same as the extremely common query whether to a) pay extra toward a mortgage or b) invest those funds in the market and pay off the mortgage later after they've grown. One has a guaranteed return, the other doesn't.

    In the analogous situation, the consensus advice is to pay toward the mortgage -- i.e., the guaranteed return. I'm at a loss as to why that is not the case here.

    It's also not clear to me whether the "interest" is counted toward the contribution limit, potentially allowing more contribution is typically possible. (Although, the limit for a 401k is pretty high, so it may not be a consideration.) A more critical question is whether you can contribute -- and receive employer match -- toward the 401k while the loan is open. This will depend on the specific arrangement you have, but it's a potential show-stopper.

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  • If the choice is solely between the EF and the buffer, I would use the EF. If push came to shove in a later emergency, the buffer could be tapped as a last resort (as can any category in the budget), but until then it's far more useful to make the budgeting process clearer and more convenient.

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    • Superbone
    • YNAB convert since 2008
    • Superbone
    • 1 mth ago
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    dakinemaui said:
    In the analogous situation, the consensus advice is to pay toward the mortgage -- i.e., the guaranteed return. I'm at a loss as to why that is not the case here.

    Huh? Since when is that the consensus? I totally disagree. There shouldn’t even be a consensus. Each situation is different and depends on the people involved.

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    • Superbone Perhaps consensus is the wrong word. Vast majority of opinions expressed by financial advisors and even posters here? I think even you have said not to invest money you need within 5 years because there is no time to recover from a market downturn. (Certainly could be mistaken on your position.) OP has said this is a short term endeavor, which I take to mean 1-2 years.

      The retirement timeline is not a consideration because the balance is restored relatively quickly to allow long-term gains to occur.

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