Should You Use 401(k) Money for a Down Payment?

Did you know you can borrow money from your 401(k) plan to buy a home? That’s right, you can essentially loan yourself the money! This option provides a lump sum of money that’s already yours – not the bank’s, not your parents’, not anyone else’s!

It’s natural to feel cautious about dipping into your retirement funds. However, it’s worth weighing the long-term pros and cons if you’re hoping to become a homeowner sooner rather than later.

Finding money for a down payment can be stressful for many buyers, especially if it’s your first time. Your 401(k) is just one option among many, including gifts or loans from family, assistance programs for low to mid-income buyers, or mortgage plans with low down payments like FHA or VA loans.

Let’s review what you can typically expect if you borrow or withdraw money from your 401(k) account. And remember, always consult with your tax professional or financial advisor before making any decisions.

Borrow from Yourself

First, check if your 401(k) plan offers a loan option. Many do, unlike IRAs, which only allow early withdrawals. Here are some key points about 401(k) loans:

• Loan Amount: You can borrow up to 50% of your vested account balance, with a maximum of $50,000. You must be currently employed by the company sponsoring your plan.
• No Credit Check: No lender approval or credit check is required. However, your mortgage lender will consider this loan when evaluating you for a mortgage. Smaller loan amounts may not impact your mortgage qualification as much. Discuss this with your mortgage lender if you’re considering this loan for your down payment.
• Lower Interest Rate: The interest rate is typically lower than standard loans, and you’ll be repaying yourself – not the bank. However, interest payments aren’t tax-deductible, and you won’t be earning interest on the borrowed money that’s no longer in your account.
• Repayment: You must repay the loan within five years, with payments automatically deducted from your paycheck.
• Job Changes: If you leave your job before repaying the loan, you’ll have 60 to 90 days to repay it in full. If not, you’ll incur a 10% penalty and the loan will be taxed as income. So, don’t plan on changing jobs during the repayment period!

Withdrawal Funds

Alternatively, you might be able to withdraw funds instead of taking a loan. However, this usually comes with strict restrictions set by your employer.

• Hardship Exemption: Generally, you won’t qualify for a “hardship exemption” for a home down payment.
• Taxes and Penalties: If you withdraw funds early, you’ll owe income tax on the amount and could face a 10% federal tax penalty if you’re younger than 59 1/2.

As you can see, borrowing from your 401(k) can be a more viable option for many first-time buyers than withdrawing funds entirely.

I’d be happy to discuss this option with you further. Also, make sure to consult with your tax advisor, financial advisor, and lender to understand any specific ramifications you might face with a 401(k) loan. With advice from your team of advisors, you’ll be able to decide if borrowing from your 401(k) is the right move for you.