Invest In a 401k or Save For a House? Here’s How to Decide, Based on Your Situation

Part of the American dream is homeownership. Quite a lot of modern America was populated by people searching for a piece of land of their own. There isn’t a Wild West where you can claim a house anymore, but if you’re reading this, you’re probably considering buying a home. At the same time, you know saving up for a house is a challenge … and you’re not really sure if you should be doing so, especially if you’re also thinking about investing in a 401(k).

So where should you put your money — invest in a 401(k) or save for a house? What is your ideal retirement strategy? Is trusting the stock market will go up over time the right path, or is opting to invest in the solid tangible asset of a house a better bet?

For a lot of people, investing in a house feels like a better decision because your mortgage payments could potentially replace your rent payments, and that can feel better than the numbers on a computer screen showing your 401(k) ticking up over time.

But what you need to consider is if it’s useful for you in your specific situation to divert savings from one big area of life (retirement) and into another. Here’s how you can think about this decision.

Invest in 401k or save for a house: Things to consider

In a perfect world, you earn enough money to both max out your 401(k) and save up for a house — but if you need to prioritize one over the other for now (and most of us do), then there are a few factors you should consider.

How much will you need to save for a house? Is it $10,000 or $50,000 to meet your down payment needs and have a manageable mortgage? This will depend on where you live and the type and size of house you want to buy.

How long do you plan to live in the house? Is this a house you’ll live in for the next 25 years, or will you be likely to sell in a few years to upgrade, downgrade, or to relocate for work or personal reasons? Or, on yet another hand, is this house purely an investment property?

How many years until you plan to retire? Are you going to be able to let your home’s value increase over time and choose a good market to sell in, or will you be selling the house rather quickly and with minimal equity growth?

Does your employer match your 401(k)? And if so, at what rate, and what is the maximum percentage or amount that they’ll match? If your employer is matching your contributions and you lower or stop them, that’s free money you could be throwing away.

What are the lifestyle implications if you do or don’t buy now? Will buying improve or diminish your quality of life?

How liquid are your assets? By keeping a large percentage of your income in a 401(k), will you negatively impact your life? Will buying a house make you house-rich but cash-poor?

What other options are available to you? Can you rent cheaply or live free somewhere? Do you have other investment opportunities?

How much will you need to save for a house?

This will depend on how much homes cost in your area, how much house you want (how many beds/baths and square footage), the type of loan you are getting, and more.

If you live in a low cost of living (LCOL) area and are single, you won’t need to spend as much for a comfortable space for one as you would if you live in a high cost of living (HCOL) area and have a partner, three kids, and a dog.

Additionally, your loan type will determine the minimum down payment you will need to have saved before you can qualify for a loan. Minimum down payments can range from as low as 0% up to 5% or even higher, depending on your loan and financial position.

If you already own a house and are looking at an investment property, you may be able to use some of the equity in your current house and convert it to a down payment for your investment property.

Jami Romstadt, a Toledo, Ohio agent who has opted to buy investment properties herself, explained how she’s leveraging homeownership to make her investment dreams come true;

“We don’t own outright; we have a mortgage on my current home, but I am able to use the equity in my current home to purchase my first [investment] property.”How many years until you plan to retire?

The younger you are, the more you can put your 401(k) money to work for you — it’s not necessarily a good idea to pull more money out earlier! The impact of compounding interest is incredible over decades, so if you’re in your 20s or 30s, you may actually earn more over time from compounding interest than from housing market value increases.

For example, if you’re 30 and you have $30,000 to invest in a home or 401(k), the very conservative 7% compounding interest adds up over 35 years. That initial $30,000 would have compounded into $345,184.56 in your 401(k) by the time you retire at 65, assuming no additional contributions were made.

However, if you’re 55 and you have $30,000 to invest in a home or 401(k), the same conservative 7% compounding interest rate over 10 years doesn’t equal nearly as much. You’d have a total of $60,289.84 in your 401k by the time you retire at 65, assuming no additional contributions were made.

It may be a good idea for you to talk to a financial advisor about the possible repercussions if you divert some of your savings or take money out of your 401(k).

How long do you plan to live in the house?

It costs money to buy a house; there’s a “break-even” point at which the money you save from renting — and the wealth you’re gaining in equity — matches what you spent to get into your house, but it takes a few years to get there (three-to-five years is typically a realistic ballpark.) If you aren’t planning on living there for a long time, it might be better to rent and wait to buy after you move to wherever you are going next.

Does your employer match your 401(k)?

Many employers match 401(k) contributions, generally with a limit to how much they’ll match. If your employer does match, then you could miss out on hundreds of dollars each year if you don’t invest up to the match amount, even if the match amount is low.

For example: a common match amount is 6% of your salary. So if your salary is $50,000, then 6% is $3,000. If you contribute the full $3,000, your employer will match some percentage of that — often up to 50% — which would be a free $1,500 each year.

One option might be to save just up to the matching amount and then divert the rest of that possible 401(k) savings into a down payment fund, but any employer matching is a benefit you should probably take full advantage of while you can.

Jake Oyler, a Financial Advisor at Colwyn Investments, works with clients to help them figure out their best option and advises, “If the company you work for has a 401(k) match program, you should contribute at least the amount that the company will match. If you don’t contribute at least that much, you are leaving free money on the table.”

Remember, too, that your 401(k) contributions are pre-tax, whereas mortgage savings are post-tax, so you can usually increase your balance more rapidly in a 401(k).

If your employer doesn’t match your 401(k) or you’re self-employed, it may make more sense for you to invest in a house, whether you live in it or choose to rent it out.

Romstadt has chosen exactly this route after considering starting her own 401(k) program when she became an independent real estate agent.

With her investment property, she explained that she is “letting the renters basically pay the house payment, and then turning around and investing that income once the house is paid off.”

What are the lifestyle implications?

There are non-financial benefits of being a homeowner, and those should certainly be taken into account — this isn’t just a financial decision. What will homeownership add to your quality of life that isn’t currently available, and how important are the additions?

Will having a home of your own bring you peace of mind that you aren’t relying on the goodwill of landlords to have stability or repairs done? Will it be better for your family to settle in and make a home theirs with a swingset out back and the ability to mark up the walls measuring your kids’ growth spurts?

Do you have mobility or any other constraints, and will being able to modify your house make life more comfortable? Do you have loved ones whom you’d like to have move in with you?

If the house is an investment properly, what will the monthly rental income do for your budget once it hits the break-even point? When is that point for the sort of investment property you’re considering, given your current financial situation?

How liquid are your assets?

While most people think of buying a house as freezing your money, that isn’t entirely true — you can always sell the house, and in a good market, you can often do so very quickly and at a profit. You also have the option of tapping into your equity through refinancing.

Putting your money in a 401(k), however, means you typically won’t touch it until you retire.  Not unless you want to pay the IRS a hefty penalty, usually in the 10% range.

If you’re planning to put a big chunk of your income into either a house or a 401(k), consider how liquid you need that money to be between now and retirement.

MaryBeth Harrison, a Simple Sale specialist in Dallas, Texas, with over 30 years of real estate experience helps her clients figure out what will best suit their needs and goals, articulating,

“I don’t want my clients living their entire being to be in this house that they stretch themselves so then they can’t do anything else but buy this house. So sometimes I do have to talk them through the logistics of what they’re stepping into.

“I don’t want their house to be their entire world. I want them to be able to go out to dinner and go out of town and have a house. I help them think through that bigger picture.”

What other options are available to you?

Consider what other options you have when it comes to savings. After all, a mortgage and a 401(k) aren’t the only ways to invest your money that exist, and it’s possible that you could find money elsewhere that could make it possible for you to have it all — both a mortgage and a robust 401(k).

Do you have another type of savings account?

An IRA can allow you to withdraw contributions without penalties, so if you are looking to withdraw from an account, this may be a better choice.

Government bonds and certificates of deposit (CDs) are both low-risk, modest-return investments that could be relatively easily cashed out and the liquidity diverted to a mortgage down payment. There may be a small penalty for liquidating them early, but it generally isn’t too bad.

Can you put down a smaller down payment (less than 20%) and pay mortgage insurance?

Sometimes, this is actually the best option, and you can leave your retirement untouched.

Mortgage insurance can allow you to make a lower down payment. The cost of the insurance will depend on various factors, but typically costs between 0.5% and 1% of the loan amount annually.

Mortgage insurance payments are bundled into your mortgage payments, and you will typically only need to make them until you’ve paid off 20% of your home’s value, so they aren’t necessarily a long-term expense; but they can buy you a little wiggle room on how much you need to have for your down payment. (Some FHA loans require mortgage insurance for the lifetime of the loan, however.)

Do you qualify for any loan programs that allow you to put down lower down payments?

Some local programs in high-cost areas will let you put down less than 20% (for example, 5%) without having to pay mortgage insurance. There are also federal programs that can help, especially if you are a first-time buyer.

First-time homebuyer programs offer loans and grants with a goal of making it easier for those who are buying their first home.

A FHA or USDA or VA loan can massively reduce down payment requirements (possibly as low as zero), which would enable you to make the jump from rent to a mortgage payment with little-to-no impact on your 401(k) savings ability.

Can you take advantage of gifts?

Your family members or friends can gift you up to $15,000 each tax-free in 2021. If you have parents, siblings, other family members or friends who are willing and able to help you with your down payment or 401(k) contributions, they could do so with a minimal or non-existent tax burden. However, keep in mind that different loan types have varying rules for down payment gifts, so check with your lender to make sure you’re in compliance with their guidelines.

Can you cut corners or increase your earnings in another way?

If you have no other options, it’s time to take a look at your expenses and see what you can trim. We aren’t going to recommend you give up your Starbucks indulgences, but if there is something you can live without, doing so temporarily in order to make your homeownership dreams come true could be worth it.

If there is nothing you can reasonably cut out, consider how you could make more money. The gig economy is still going strong, so you could choose to pick up a part-time job … or maybe it’s time to ask your full-time job for that hard-earned raise.

So, what should you do?

Most experts are going to recommend that people prioritize their 401k, but if homeownership has always been a big financial goal of yours, that should be taken into consideration!

Robert R. Johnson, PhD, CFA, CAIA, Professor of Finance, Heider College of Business, Creighton University in Omaha, Nebraska, explains that “financial decisions aren’t binary. One must weigh many competing goals when managing one’s financial affairs — funding a child’s college fund, purchasing a home, paying down debt, etc. It is more of a choice on which to put more weight on, not foregoing one altogether.”

Talk to a financial expert about how much you should expect to save up, and where it makes sense to budget, so you can make the best decision for your household and your goals.

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