Should You Use 401k Money for a Down Payment?
Photo by Moja Msanii on Unsplash
Did you know that you can borrow from yourself if you have a 401k plan?
Getting a 401k loan is one way to get additional money toward a down payment. It’s a lump sum of money that is already yours -- not the bank’s!
It’s understandable if you may be wary of using any retirement funds for anything other than retirement. However, it’s worth evaluating the long-term pros and cons of borrowing this money if you want to buy a home sooner than later.
Finding money for a down payment can be stressful for many buyers, whether you are a first timer, or when you are buying and selling at the same time and your downpayment for the new home is in the home you still need to sell!
Your 401k is just one option out of others for getting some cash -- getting a gift or loan from a family member, qualifying for assistance programs for low to mid-income buyers, or looking at mortgage plans with low down payments such as a FHA loan.
Take some time to review the highlights below of what you can typically expect if you borrow or withdraw money from your 401k account.
And, as always, I recommend that you consult with your own tax or financial advisor before you pursue anything.
Borrow from Yourself
First off, you’ll need to double check to see if your particular 401k plan offers a loan option. Many 401k plans offer loans unlike IRAs, which only offer early withdrawals. Here is some key information on typical 401k loans:
Up to 50% of your vested account balance can be borrowed, with a maximum of $50,000. You usually have to be currently employed by the sponsoring employer of your plan.
No credit check or approval by a lender required. However, your mortgage lender will consider this loan when it evaluates you for a mortgage. Smaller loan amounts won’t affect your mortgage qualification as much. Check with your mortgage lender if you are thinking of taking this loan for your down payment.
Lower interest rate than standard loans. You’ll be paying yourself that interest (along with the principal) back into your account, not the bank. However, interest payments aren’t tax deductible, so that’s one cost of borrowing from your account. And, you won’t be earning any interest on the money that’s no longer in your account.
Full repayment required within 5 years. Yes, you’ll need to repay back this loan to yourself. Can be automatically deducted from your paycheck monthly into your 401k account.
60-to-90- day time period to pay the loan back in full if you leave your job before repayment. Or you will incur a 10% penalty and have it taxed as income. So don’t plan on changing jobs or getting fired during the repayment period!
Withdrawal Funds
You may also have the option of withdrawing the funds rather than setting up a loan. However, there are usually stringent restrictions in order for your employer to allow in-service withdrawals.
For example, you won’t be approved for a “hardship exemption” since you’re using it for a down payment on a home.
If your plan allows an early withdrawal funds, you’ll owe income tax on that amount and you could be subject to a 10% Federal tax penalty if you’re younger than 59 1/2.
As you can see, borrowing from your 401k plan can be a more viable option for many first-time buyers than a complete withdrawal.
Check with your tax advisor and mortgage lender to learn any specific ramifications you may face with a 401k loan. You can see if a small loan to bump up your down payment funds is worth it or not.
I hope this information has helped you think about whether borrowing from your 401k to fund your homeownership dreams is something you want to do or not. If you’d like to talk more about your financing options, I’d be happy to talk more anytime. Email me when you are ready to chat. I’m here for you!