Should You Use 401k Money for a Down Payment?

Should You Use 401k Money for a Down Payment?

Did you know that you can borrow money to buy a home 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, not mom and dad’s, and not anyone else’s!

It’s understandable if you may be wary of using any retirement funds at this time. However, you might want to evaluate 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 first-time buyers. Your 401k is just one option out of others for getting some cash — getting a gift from a family member, qualifying for assistance programs, or looking at mortgage plans with low down payments are other options.

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 allows you to withdraw money from it. Many 401k plans offer loans unlike IRAs. Here is some key information on typical 401k loans:

• Up to 50% of your vested account balance can be borrowed. You will need to ask your account manager if there is a maximum amount for your account. You usually have to be currently employed by the sponsoring employer of your plan.
• No credit check or approval required. However, for qualifying purposes, we will consider the repayment terms. Smaller loan amounts don’t tend to affect your mortgage qualification as much. Be sure to check with me first 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. 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 typically required within 5 years. Yes, you’ll need to repay back this loan to yourself. This can be automatically deducted from your paycheck monthly into your 401k account.
• There is typically a 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. 

I’m happy to talk more about this option with you.  Also check with your tax advisor, financial advisor and with me to learn any specific ramifications you may face with a 401k loan. By talking to your team of advisors, you’ll be able to decide if borrowing from your 401k is worth it or not.