If you’re struggling to save enough for a downpayment, you may be wondering if tapping into your 401(k) is the right option. While it’s possible, doing so comes with significant risks, like early withdrawal penalties and lost investment growth.
In this Redfin article, we’ll answer your questions about using your 401(k) to buy a home through loans or withdrawals and the drawbacks of the process. That way, whether you’re buying a home in Tampa, FL, or in Newark, NJ, you’ll know what options are available if you want to use your 401(k).
Key takeaways
- You can use your 401(k) to buy a home with a 401(k) loan or withdrawal.
- A 401(k) loan allows you to borrow the money without penalty, but you need to repay it.
- A 401(k) withdrawal is subject to a 10% penalty and income tax.
Can I use my 401(k) to buy a house?
The short answer is yes, you can use your 401(k) to buy a house. There are two options to consider – 401(k) loans and 401(k) withdrawals.
401(k) loans to buy a house
The first option is a 401(k) loan for your home purchase. A 401(k) loan allows you to borrow from yourself, so you don’t have to pay penalties or taxes on the funds. However, you’ll need to pay back the loan with interest.
Most 401(k) loan interest rates and repayment plans are pre-determined by your employer or 401(k) provider. It’s common to repay the amount within five years, but some plans allow you to repay over 15 years if the funds are used to buy a home.
You can usually borrow up to half of the money in your 401(k) that you fully own (your “vested balance”), but no more than $50,000.
Depending on your 401(k) plan, you may not be able to make additional contributions until you pay back the loan. Any loan repayments are not considered new contributions either.
401(k) withdrawals to buy a house
Withdrawing from your 401(k) can be riskier, but there are reasons why it may work for you. Some 401(k) providers don’t allow loans, so withdrawing may be the only option available. Additionally, if you need more than $50,000, withdrawing can give you more funds.
There are other drawbacks to keep in mind:
- If you’re under 59 ½ years old, you’ll incur a 10% penalty for withdrawing from your 401(k), unless you meet certain exemption requirements. You’ll also need to pay income tax on any money withdrawn from your account, even if you meet the exemption requirements.
- If you have a Roth 401(k), your contributions are made after taxes, so you can usually withdraw contributions without additional taxes. However, withdrawing earnings before age 59½ (and before the account has been open for at least five years) may trigger taxes and penalties.
When can you withdraw from your 401(k) without penalty?
A hardship withdrawal allows you to withdraw from your 401(k) without penalty, but is restricted to “immediate and heavy financial need.” Here are some examples of what circumstances may qualify:
- Certain medical expenses or medical debt
- Expenses to prevent eviction or foreclosure
- Income after the withdrawal age of 59 ½
- Funeral expenses for certain family members
- 12 months of educational expenses, like tuition
There are additional circumstances that may qualify as a hardship withdrawal, so be sure to research your options. For example, you may qualify for a hardship withdrawal to cover your down payment or closing costs. However, these rules can be strict and you may still need to pay the 10% penalty on the funds you withdraw.
How to borrow from your 401(k) account to buy a house
To borrow from your 401(k) loan to finance a down payment, you’ll need to talk to your employer’s benefits office or HR department, or with your 401(k) plan provider. You can also consult your plan document to find out if your plan permits borrowing from your 401(k) to purchase a home.
You’ll want to find out how much you’re able to borrow, the interest you’ll have to pay, and the repayment period. Additionally, ask about repayment options, such as whether your employer will deduct the monthly payment from your paycheck or if they will allow you to make 401(k) contributions while you pay back the loan.
If you choose to leave or lose your job during the repayment period, your repayment schedule will change. Most times, you’ll need to repay the total amount by the next tax deadline. If you don’t, you’ll face a 10% penalty.
Pros and cons of buying a home with 401(k)
Here are some factors to consider before using your 401(k) to buy a home:
Pros of using 401(k) funds
Easier qualification process: With most loan approvals, they’ll examine your finances and run a credit check. Typically, applying for a 401(k) loan doesn’t need that information since the money is already yours.
Receive funds faster: You’ll usually get the funds within a few days since the approval process is much faster.
You receive the interest payments: Unlike a mortgage loan, your interest payments don’t go to the lender. Any interest payments go back into your 401(k) as part of the repayment process.
401(k) loans don’t count towards your debt-to-income ratio: Your debt-to-income ratio (DTI) is typically used when you apply for a new line of credit or loan. A 401(k) loan won’t impact your DTI, meaning you could apply for a new credit card or get a car loan if needed.
Cons of using 401(k) funds
Reduced retirement savings: When you withdraw or take out a loan, you’ll lose some of your retirement savings. While you’ll eventually pay them back, this temporary reduction in savings may lead to long-term losses.
Taxes and additional penalties: If you choose to withdraw 401(k) funds, you’ll have to pay income taxes on the funds. You’ll also have to pay a 10% penalty for withdrawing those funds early.
Lost investment growth and contributions: Some 401(k) accounts won’t let you contribute to the account while you repay your loan. You may lose out on the interest your funds build as well.
Additional monthly payments: While you repay your loans, you’ll have to factor that into your monthly payments. In some cases, repayments are made with after-tax dollars and may be taken directly from your paycheck, which could cause additional financial strain.
Is using a 401(k) to buy a home a good idea?
Using a 401(k) to buy a home can work in certain situations, but it comes with risks. It may make sense if:
- You have no other savings
- You qualify for a 401(k) loan with reasonable repayment terms
- You plan to stay in the home long-term
Alternatives to using your 401(k) to buy a house
There are several alternatives to using your 401(k) to buy a home. Let’s take a look at them:
Individual retirement accounts (IRAs)
Individual retirement accounts (IRAs) have options available for first-time homebuyers and those who have not owned a primary residence for two years. This gives you the opportunity to withdraw up to $10,000 for traditional or Roth IRAs with no penalty, even if you’re under 59 ½ years of age. Consider speaking with your financial advisor if you have questions.
Low and no-downpayment mortgages
There are plenty of low and no-downpayment mortgages available for qualified homebuyers, like FHA, USDA, and VA loans. For example, FHA loans, backed by the Federal Housing Authority, offer loans with down payments as low as 3.5%. These loans have more stringent requirements, so it may not be the right option for everyone.
Down payment assistance programs
Whether you’re a first-time homebuyer or a repeat buyer, there are plenty of down payment assistance programs available. Most are geared toward first-time buyers, but there are lots of options that reduce the amount you pay in down payment or closing costs.
FAQs about using your 401(k) to buy a house
What is a 401(k)?
A 401(k) is a type of retirement savings account, where you elect a certain portion of your income to go into the account. There are two types of 401(k) accounts, a traditional 401(k) and a Roth 401(k). Traditional 401(k) contributions are pre-tax, so you’ll be taxed once taking them out. On the other hand, a Roth 401(k) has taxes taken out before contributing, so you won’t have to pay tax on them later.
Will my employer know if I withdraw from my 401(k)?
Your employer, most likely the human resources department, will know if you withdraw from your 401(k), but not your direct manager.
How does withdrawing from a 401(k) affect mortgage approval?
Using a 401(k) loan or withdrawal can impact your mortgage application in different ways. While a 401(k) loan won’t count against your debt-to-income (DTI) ratio, a withdrawal could reduce your available assets and affect your lender’s view of your financial stability. Always check with your lender before using 401(k) funds for a home purchase.
Can I use a 401(k) loan and withdrawal at the same time to buy a house?
In most cases, you can’t combine a 401(k) loan and withdrawal at the same time. Most plans only allow one type of 401(k) distribution at a time, but this depends on your employer’s plan rules.
Is there a 401(k) first-time homebuyer exemption?
There are no exemptions for first-time homebuyers looking to use their 401(k) to fund their home purchase.
Can I use my 401(k) to buy a second home?
Yes, you can use your 401(k) to buy a second property. You’ll still face the same penalties and repayment regardless of whether you have a loan or withdraw funds.
Can I use my 401(k) to cover closing costs?
Yes, you can use a 401(k) loan or withdrawal to cover closing costs, including lender fees, appraisal costs, and escrow expenses. Withdrawals still come with penalties and taxes, while loans must be repaid.
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