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Using Your 401K to Buy a House
If you’re considering buying a house but cringe at the thought of making the down payment, you aren’t alone. Younger buyers, especially millennials, have difficulty making a down payment due to a lack of savings. In fact, 28% of younger millennials used borrowed or gift funds to make their down payment.
What if you don’t have access to gifted funds? Where do you borrow the funds? Unless you have a wealthy relative or friend, you might consider your 401K. Here’s what you must know about using your 401K to buy a house.
What is a 401K and When can you Use It?
A 401K is a retirement account sponsored by an employer. It’s a defined contribution plan that allows account holders to contribute funds pre-tax and employers to match contributions as they choose.
Typically, the funds you put in a 401K are kept there until you retire. In a standard 401K, you contribute the funds before paying taxes, deferring your tax liability until you retire. When you withdraw money during retirement, you pay taxes on the money you contributed and any earnings at your current tax rate. As a result, most people are in a lower tax bracket during retirement, saving them money.
If you withdraw funds early (before age 59 ½), you might pay a 10% early withdrawal penalty plus applicable taxes on the funds withdrawn, but there are some exceptions.
Can you Withdraw from your 401K to Buy a Home?
You might have heard that you can withdraw up to $10,000 from your IRA to buy your first home and not pay the 10% penalty. So, is the same true of a 401K?
It’s a tricky answer.
You can withdraw from your 401K and use the funds to buy a house, but you may pay a penalty. It’s not the right choice for everyone; here’s what you must know.
Types of 401K Withdrawals
There are two types of 401K withdrawals – an actual withdrawal and a 401K loan.
A 401K withdrawal before age 59 ½ usually incurs a 10% penalty on the amount withdrawn plus applicable taxes. There is one exception. If you have a Roth 401K, you already paid taxes on the funds (Roth contributions are after tax), and as long as you only withdraw contributions and not earnings, you don’t pay taxes.
If you have a regular 401K, though, you’ll pay the penalty and taxes, which will decrease the money you have to put down on a home, and it probably isn’t the best idea to do.
However, another option is a 401K loan. Many companies allow you to borrow against your retirement funds. You must repay the amount borrowed with interest, but you’re repaying yourself.
Each company has different rules, so talk to your 401K sponsor about your options. Some may even offer a hardship withdrawal and allow purchasing your first home to be considered a hardship.
Pros and Cons of Using Your 401K to Buy a House
The most attractive way to use your 401K to buy a house is to borrow from it, but that has good and bad sides. Here’s what you should know.
Pros:
- You don’t have to worry about getting approved – If your company allows 401K loans, you are automatically eligible. You don’t have to go through a credit check or prove your income.
- You can get your funds fast – Most companies can fund a 401K loan in a matter of days, allowing you to have the necessary funds available when you apply for a loan.
- You pay yourself back – Even though you pay interest on the borrowed funds, you pay yourself back. This ensures you’ll still have money available for retirement because you’ve paid yourself the principal plus interest.
Cons:
- You run the risk of a penalty – Depending on your company’s policies, you may have to take a withdrawal, not a loan, and pay the 10% penalty.
- You take away from your retirement – Even though you pay yourself back with interest, you lose the compound earnings the money would have earned if you left it untouched.
- It’s like having two loans – Borrowing to borrow money isn’t the best financial decision. Owing two loans as a new homeowner can be overwhelming.
Other Options for a Down Payment on a Home
Fortunately, borrowing from your 401K isn’t the only option to buy a home. Here are a few alternatives.
- Look at low down payment loans – FHA loans are an excellent example of a low-down payment loan. You might need only 3.5% down payment.
- Borrow from a friend or family member – Consider a loan from family or friends instead of borrowing from your retirement account. You may get better terms and don’t have to worry about hurting your retirement funds.
- Withdraw from your IRA – You may withdraw up to $10,000 from your IRA without any penalties. This allows you to access the full amount of the funds without worrying about paying it back or a fee.
- Delay the purchase and save – Another way to buy a house is to wait until you have money saved to pay for it yourself. Create a budget that makes room for enough money to make the down payment without borrowing to buy a house.
Final Thoughts
You can use your 401K to buy a house, but it’s not always the right choice. Consider it your last resort if you don’t have funds to put down on the house.
If you can’t get the money any other way, your employer may allow a 401K loan. Just be sure you can pay it back quickly and won’t rob your future self of too much of your retirement funds. Consider this option only if you don’t have any other options, including your own savings, borrowing from friends or family, and taking money from your IRA.
At Innovative Mortgage Brokers, our primary goal is to provide you with a variety of options, ensuring you have the best possible choices when it comes to securing a mortgage. If you are looking for a mortgage in Pennsylvania (PA) or Florida (FL), here’s what we can offer:
Access to a wide range of lenders: At Innovative Mortgage Brokers we work with numerous lenders, including banks, credit unions, and non-traditional lenders. This extensive network allows us to present you with multiple loan products, so you can find one that best suits your needs.
Customized loan solutions: Every borrower’s financial situation is unique. We take the time to understand your specific requirements and goals to recommend tailored mortgage solutions that align with your individual circumstances.
Competitive interest rates and terms: Our strong relationships with lenders enable us to negotiate on your behalf to secure competitive interest rates and loan terms. This can potentially save you thousands of dollars over the life of your mortgage.
Expert guidance and support: Navigating the mortgage process can be complex and confusing. We offer expert advice and support throughout the entire process, from pre-approval to closing, ensuring that you make informed decisions at every step.
Assistance with special circumstances: If you have unique financial circumstances, such as self-employment income or student loan payments, we can help you explore specialized loan programs and options that accommodate your specific needs.
Streamlined application process: We simplify the mortgage application process by handling much of the paperwork and communication with lenders on your behalf. This saves you time and reduces the stress associated with securing a mortgage.
In summary, at Innovative Mortgage Brokers, we are committed to providing you with a diverse range of mortgage options, expert guidance, and personalized service. Our aim is to help you find the perfect mortgage solution that meets your financial goals and makes your homeownership dreams a reality.