Based on the title of this post alone I guarantee there will be some hardcore zero debt personal finance fanatics who think I’m the dumbest person on the planet, but I’m here to take a radical position: paying interest isn’t always so bad.
Does paying interest suck? Absolutely. But sometimes you need to borrow and the only way to do it is to pay a little bit of interest.
Let me explain.
I’m Paying Interest for Cash Flow
I’m closing on my house in less than a month and I need to pay for my 20% down payment plus any other closing costs. That’s going to cost me tens of thousands of dollars.
photo credit: PTMoney
I had to sell essentially all of my stocks, drain my Roth IRA, and even take a loan against my 401k to get the money for the down payment, but after doing all of that I now have enough money for closing.
I should also mention I bought my fiancee’s engagement ring with my credit card (which I usually pay off every month). That credit card bill is due in a few days and I can either pay it off completely like usual or pay a smaller amount and carry a balance.
If I pay it off completely it’s going to put me right around the amount that I need for closing on my house. I actually don’t even know exactly how much I’ll need at closing because all the paperwork and stuff isn’t done, so it might leave me a little short.
If I show up to closing and I don’t have enough money in my account then that’s going to be a very serious problem. I don’t even know what exactly would happen but I’m sure it would be bad.
On the other hand I can pay off some of it and leave a $2,000 balance on which I would pay interest for one, maybe two months.
The Cost to Carry a Balance
The APR on my credit card is 11.24%. If I carry a $2,000 balance on that card for one month I will pay just $18.73 in interest. If I carry that balance for two months it’s $37.46.
If I were to borrow $2,000 from a friend for a month I’d probably pay him back and then take him out to dinner as a “thank you”. The dinner would cost me more than $18.73.
Also keep in mind that I get rewards on my credit card. This particular card gets at least 2% back, which means I already got $40.00 in rewards when I spent that $2,000. Even if I pay interest on it for two months I still make money.
It doesn’t sound like such a bad idea anymore, huh?
There are No Absolutes in Personal Finance
Lots of people would tell you that debt is never acceptable. Those people would tell me to either pay off my entire credit card and risk not having enough money at closing, or they would tell me that I’m an idiot for buying a house without being 100% sure I could pay the closing costs without going into debt.
Those people would call me an idiot for spending $20 to borrow money to buy a freaking house!!!!
Those people are the idiots in my opinion.
Carrying a balance on your credit card every month is a great way to lost a lot of money and make your credit card issuer rich. Carrying a balance for just one or two months is a shrewd way of getting a very low interest short-term loan.
Readers: Have you ever borrowed money and paid interest because you needed the cash flow?
I read this title and thought, “oh man, this is gonna make waves.” But I happen to agree with you. Someitmes we have to do these things to make stuff work. You aren’t pulling from your IRA and paying interest on the credit card for some fancy new shoes for your girlfriend or a new escalade or something. You’re doing it for something important, for a real investment. I’ve had to carry balances on card beforea nd taken out loans, and while it’s nice if you have a big enough emergency fund or savings to cover it all, that just isn’t always realistic or what happens. *shrug* I think it’s okay dude, congrats on almost owning a house! 🙂
It’s not just the house. It’s the combination of the house and getting engaged to the love of my life. I think both those things are worth a few bucks in interest! 🙂
After reading your post, the thing I would be concerned about is not having any money once the house closes. It looks like you drained all of your saves… So, what happens if an emergency arises? What if something in your house breaks and you have to fix it? Does your fiancee still have savings?
I did drain quite a bit of money for the house, but that was intentional.
If a health emergency arises, I have over $6,000 in my Health Savings Account. If some other emergency arises I have plenty of available credit I could use (including balance transfers at 0% for 12 or 18 months). If something in the house breaks I have a home warranty for at least the first year so a fix would just cost me $60.
It’s true that I have drained a lot of my savings. It’s also true that I went from basically 100% of my net worth in stocks and cash to a nicely diversified portfolio of a physical asset (my new house) plus what I have in my 401k and a few other savings I still have.
I had the same thoughts as David reading this. Selling stocks isn’t a big deal, but taking money out of retirement with interest and early withdrawal penalties indicates that you can’t really afford a house right now. Ideally down payment money should come from checking and savings accounts while still leaving enough money to cover at least 6 months of expenses.
I disagree. I didn’t pay a dime in early withdrawal penalties, and the only interest I’m paying (aside from this $20 or $40 I wrote about in the article) is 4.25% interest on the 401k loan, which I pay to MYSELF.
Without the house I was almost 100% invested in stocks and cash. If we went into a serious depression or experienced hyperinflation then I would be screwed. Now that I’ve diversified into a physical asset I feel much more comfortable about my financial situation.
Kevin, I really hope nothing goes awry for you in this scheme. I think you have crawled out onto a very thin branch. Why did you choose to jump into a house before you were financially prepared?
Because we have a very different opinion about whether or not I’m financially prepared.
As I’ve said in other comments, I was extremely uncomfortable having so much of my net worth in cash and stocks. I wanted to diversify into something physical. The bulk of my net worth was in my 401k and it doesn’t have precious metal investment options or any other physical asset options. Buying a house with a 401k loan was the only way I could diversify my 401k into a combination of physical and cash/stock assets.
I’m preparing myself for very tough economic times ahead, and I didn’t want to be caught with nothing to protect myself from hyperinflation. My house is my protection against that now.
Again, this wasn’t a knee jerk “I want that house” move. It was a calculated decision to diversify my assets and actually put money into something that will be valuable no matter where our economy goes.
I personally haven’t borrowed because I needed cash flow but I have borrowed for other reasons. It makes sense in this case but there will be people who will say you should have been more prepared or had more in buffer. Just do what is right for you and don’t worry about what others think. $40 definitely wont kill you.
Sure I could have waited a few months and saved up more money, but I was ready now. Also, the only reason I’m keeping a $2k balance is because I just don’t know exactly how much I need to bring to closing because mortgages are complicated. It may end up that I had enough money all along (which I think will be the case).
One of the beauties about a 401k (or 403b) is that you can borrow a loan against yourself for things like a down payment. This is actually a big reason that I keep a 403b– So that I can borrow, if needed (although I never have).
One of the beauties about a Roth IRA is that you can withdraw without penalty on your contributions, and also that they have a special early withdraw exception for first-time home-buyers.
I looked into buying a house last month, and although it didn’t pan out I was going to do exactly the same thing that you did with my 403b and Roth IRA. I know that these are controversial decisions and that there are pros and cons on both sides– But that’s the point. It’s a decision that you have to make for yourself, and I’m certain that the concerns that other commenters have posted were already well considered by you before making the decision.
Right now is an awesome time to buy a house. I (obviously) totally support your decision.
But to answer your question:
I currently have only $600 left on a student loan. I could have just paid it off this month but since the the interest rate is only 2.15% (yes… incredible) and I’m going to Mexico this month, I’m fine with paying the $1.13 in interest this month so I can have a few extra tacos 🙂
I’m glad we are on the same page! Enjoy Mexico and be safe!
It sounds like you may be stretching a little bit but it also sounds like you did your homework and know what you can afford. I’m not against paying a little bit of interest in the short term if it helps me accomplish my goal. Do I like debt? Hell no, but I also know that sometimes it makes sense.
How long will it take to build up enough savings to cover emergencies that wouldn’t hurt you long-term? I know you like to think of credit cards as your emergency account, but a true emergency where you need $5,000-$10,000 would take months to pay off. I think some of your commenters would feel less like you’re spreading yourself thin if it was only a few months.
Life is too short too play within the overly conservative rules of personal finance. There’s a perspective gap here. Putting down 20% is not as common as it is in pfland and I venture to guess that in this low rate environment you’ll find it very easy to pay the monthly bill. Borrowing a few bucks to get over a big hump really isn’t that big of a deal.
Congrats on buying a home, btw!
There are no absolutes — you’re right. You’ll have plenty of time to catch up.
I borrowed my downpayment 15 years ago for my current home. It was because I did not have the money, I was renting out my principle residence and my other funds were working for me in the stock market. I repaid my loan in less than 10 months. I rescently took a cart loan at 1.99% for my new car. I could have paid for it, but at such a low interest rate why bother.
I agree with the car loan. I did the exact same thing at 1.79%. I make more than that in gov’t securities, and have the cash flow to support the payment… so why spend the money up front?
Just remember that the interest won’t be charged on the $2,000 balance, it will be on the total statement balance. I just found this out last week. I usually make 2 payments to my credit card per month when I get paid. I made my first payment as usual and left the remaining balance to be paid when I get me check at the end of the month. What I didn’t take into account was that I’d be on vacation that week and not really thinking about paying bills. I paid remaining balance off when I got home 2 days after the payment due date (keep in mind I had made a previous payment so there wasn’t a late fee) and 3 days before the statement cutoff date. My statement balance was ~ $3,100 and I had made a $1,600 payment around the 15th. My credit card company, Citi, charged me interest on the whole $3,100, not the $1,500 remaining balance due. Just keep that in mind. For me it wasn’t that much of a mistake, $32, however, had I just bought a ring and carried, say a $15,000 balance, it could’ve cost me $165 or so. Still not a ton of money, but something to consider. Happy trails!
when are we going to see another “race to a million” post?
its been months and would really put the house purchase in context.
K dog,
In a prior article you said to ask the seller to pay some of the closing costs; what was your sellers answer to that question?
Did you opt for a 15 or 30 year home loan and why did you choose one over the other?
Last, have you written an article on the pros/cons and/or process of borrowing against your Roth IRA? I’m not searching for a house now, but borrowing from myself seems like a good idea when the time comes…
After paying off ALL my debt I had accumulated in college (almost 50k) I’m reluctant to use my credit card if I can’t pay it off the same month. I do, however, see the opportunity cost in carrying a balance for a couple months to ensure you can cover your closing costs. Definitely worth $20-40 to have the peace of mind.
Hey Kevin M. M. Happy recent birthday btw (it was my half birthday).
In my first offer I tried to get the seller to pay closing costs but he said no. The trouble with asking the seller to pay closing costs is that if you don’t use it you lose it. If you ask them to pay $5k in closing and closing only costs $4k, then you don’t get to pocket that extra $1,000. The way I’m paying for closing is having the bank give me a credit at closing in exchange for me taking a higher interest rate. The math says the money at closing is better as long as I sell the house within 7 years.
I did a 30 year loan because I don’t have the money for the increase payment, but if I had a little more money I’d much rather do a 15 year loan.
I’m actually going to write an article about borrowing from my 401k for next week, which is different from using your Roth IRA. You can take any contributions out of your Roth IRA and can take up to $10k of capital gains out as well as long as you’ve had the Roth IRA for 5 years or more.
I’m with you on paying off debt. I wasn’t done with my student loans until earlier this year and only had about 6 months of debt freedom before taking out a big mortgage loan. However, paying a few bucks in interest isn’t bad. It’s paying hundreds or thousands that doesn’t work for me.
Good to hear from you again and I’ll have that 401k article done sometime next week.
I’m doing much the same thing! We had the unexpected opportunity to buy acquaintances’ house, so we had to quickly pull together the down payment. Not knowing exactly how much we’ll need to close, I opted to use a balance transfer (0% interest for twelve months, 1% transfer fee) to free up the cash flow, just in case. So for less than a trip to Red Robin in fees, we know we’ll have the cash to close, pay for movers, etc. and can easily pay it back before we’d have to pay interest. Would I have preferred to just have the money and not play the transfer game? Sure, but I’d also prefer to eat anything I want and not gain weight. This works for us now, and I don’t regret it!
Oh, and I totally agree with you that there are no absolutes in personal finance. Don’t get me started on why a tax refund is totally okay.
I do not think Kevin is necessarily making a bad move.
Coming up with a 20% down payment (I did) is difficult, and many of those criticizing him probably did have to do that. It’s something more lenders are requiring due to the financial crisis and I think that’s not a bad thing, either. If Kevin feels he has job security and his fiancee does too, having a little short-term revolving debt isn’t going to do long-term damage. Kevin has youth on his side. If he bought in a good area, and is smart with his money post-marriage, he will have his investments back where they belong in no time. A home can be a great investment, just don’t fall into the trap of filling it with expensive “stuff” that doesn’t matter.
Hey, if businesses use this approach – why shouldn’t individuals. Glad to have someone else reading from the same hymn sheet!
This is a great case kevin – I’ve had to do this before, and sometimes it’s just more important to have access to cash – and buying a house is one of those times (believe me, I know)
Absolutely! I refinanced my paid off cars at .49% interest for 5 years and took out gap insurance because they are old and will break down before the 5 year period. So, I get to borrow at .49% to invest at 10+% makes sense to me.