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

Did you know that you can borrow money to buy a home from yourself if you have a 401 (k) plan?

Getting a 401 (k) 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 401 (k) 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 401 (k) 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 401 (k) plan offers a loan option. Many 401 (k) plans offer loans, unlike IRAs, which only provide early withdrawals. Here is some key information on typical 401 (k) 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 considering 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. It can be automatically deducted from your paycheck monthly into your 401 (k) 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 that your employer must follow 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 early withdrawal of 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 401 (k) plan can be a more viable option for many first-time buyers than a complete withdrawal.

I’m happy to discuss this option with you. Also, check with your tax advisor, financial advisor, and lender to learn any specific ramifications you may face with a 401 (k) loan. By talking to your team of advisors, you’ll be able to decide if borrowing from your 401 (k) is worth it.