If you have enough in your 401(k) retirement account to withdraw or borrow to buy a home, you should consult with a financial advisor to decide if it’s the right step for you. Here are some general tips on when it may make sense to use your 401(k) to buy a house.
Pros and Cons of Using a 401(k) To Buy a House
Whether you withdraw or borrow money from your 401(k), there are positives and negatives to be weighed when you’re asking, Should I use a 401(k) to buy a house?
Pros of using your 401(k)
It’s important to know that while you can use your 401(k) to buy a house, it’s not a common option. Here are some advantages to using your 401(k) to buy a house:
- If you borrow or withdraw from your 401(k), it’s a quick and simple process.
- First-time homebuyers can qualify for an exemption of up to $10,000 from the early distribution tax on a 401(k) withdrawal.
- If you’re borrowing money from your 401(k) to buy a house that will be your primary residence, you may have more time to repay the loan than the typical maximum of five years.
- When you borrow from your 401(k) and pay it back with interest, it all goes back into your account.
- There’s no effect on your credit score, since you’re borrowing from yourself.
Cons of using your 401(k)
It’s important to consider your entire financial situation and your long-term goals when buying a home. Make sure to think about the drawbacks to reducing your retirement fund, including tax liabilities. Here are disadvantages to using a 401(k) to purchase a home:
- If you fail to repay a 401(k) loan, it will be treated as an early distribution, and you’ll pay a 10% penalty and income tax on it.
- You cannot put money you take out as a withdrawal back into your account, or into another retirement account.
- You slow down the trajectory of your savings’ growth.
- If you leave or lose your job, you may be required to repay the balance of your 401(k) loan immediately.
- Certain plans, especially those that have been around for a long time, might not qualify for loans or early withdrawals.
Alternatives to Using Your 401(k) To Buy a House
Since your 401(k) is set aside for a specific reason, and because of the potential pitfalls of making your down payment this way, here are some other options to consider before committing to a 401(k) withdrawal or loan.
Tap into your Roth IRA
If you have a Roth individual retirement account, you can withdraw the amount you’ve contributed to it at any time. You cannot, however, withdraw any of the interest earned on your contributions without paying an early distribution fee. This does not apply to traditional IRAs.
Take the time to save up
If you need more saved up to afford a down payment, consider continuing to save cash before taking money out of your 401(k). Reducing your 401(k) balance means you’ll earn less interest, and over time, this can significantly reduce the total available to you at retirement.
Explore loans that require low down payments
- FHA loans. The Federal Housing Administration insures mortgage lenders against losses on loans that conform to its requirements, which include a down payment as low as 3.5% of the purchase price.
- VA loans. Eligible members of the military, veterans, and their surviving spouses may be eligible for a Veterans Affairs loan. These loans require no down payment.
- USDA loans. The U.S. Department of Agriculture offers loans with no money down for low-income borrowers buying homes in qualified rural areas.
Down payment assistance programs
Depending on where you live, the type of home you hope to purchase, and your financial situation, there may be down payment assistance programs for first-time homebuyers that could help you afford a home.
The Department of Housing and Urban Development funds most down payment assistance programs, which typically offer cash grants, closing cost credits, or low-interest loans that first-time homebuyers can use for a down payment.
How To Decide If You Should Use a 401(k) To Buy a House
Your personal situation will help you decide if you should pull money from your retirement plan to buy a home, and how to use your 401(k) to buy a home. Make sure you research and consider all the potential upsides and downsides before deciding.
Because of the potential risks and pitfalls involved, it’s a good idea to talk to a financial advisor so that you understand fully what it means to draw from your account. Your employer’s benefits administrator can explain the details of the process, and may have advisors available to help you decide if using your 401(k) savings to buy a home is right for you.
Here are answers to some questions about whether you should use your 401(k) to buy a home.