Welcome to the BeSmartee blog. Enjoy a wide selection of articles related to mortgages, the industry, and real estate.

Should You Use Your 401(K) to Purchase a Home?

By Veronica Nguyen · Jun 1, 2015 · Mortgage

Should You Use Your 401(K) to Purchase a Home?

Image courtesy of Flickr, Sean Dreilinger

You can use your 401(K) to purchase a home. We will list some things to consider when making a decision about using your 401(K) for real estate purchases.

Saving for a down payment can take a long time depending on your circumstances, which is why the option of using your 401(K) to purchase a new home can be worthwhile.

There are two ways you can withdraw money from your 401(K):

  1. A hardship withdrawal
  2. Borrowing money from your 401(K)

We will describe each in further detail in order to help you make a better decision as to which option to use, or whether or not the 401(K) option would be appropriate for your particular circumstance.

Hardship Withdrawal

The IRS will consider a 401(K) withdrawal as a hardship when you use the funds to purchase your primary residence. Making the withdrawal does comes with several consequences

401(K) Hardship Withdrawal Consequences before Age 59 ½:

  • Pay a 10% penalty
  • Pay ordinary income taxes on withdrawal amount
  • Miss out on tax-deferred earnings from the withdrawal amount on 401(K)
  • Miss out on compounding interest from the withdrawal amount on 401(K)

Borrowing From Your 401 (K)

Borrowing from you 401(K) is not a bad idea if you have a plan to pay it back. Although some financial advisors may be against borrowing from your retirement account, many people still see this as a viable option. According to research by Ameriprise Financial, 17% of millennials and 13% of Gen Xers have taken out a loan from their retirement plans.

Before borrowing from your 401(K) consider the following:

  • You must pay interest on the amount your borrow from your 401(K)
  • You can typically borrow $50,000 or half of your balance, whichever is less
  • You must repay the loan within 5 - 10 years
  • If you leave your job you must repay the loan within 2 months
  • The money you pay back to your 401(K) will not be considered a contribution
  • If you default on the 401(K) borrowed amount, it will be taxed as income
  • The money you pay back to your 401(K) will not be tax deductible

As you can see there's a lot to think about. You should consider your ability to pay for a mortgage payment and the 401(K) loan payments combined. It's easy to borrow from your 401(K) but think about other alternatives that you can use to save for a down payment.

Other alternatives to save for a down payment:

  • Cut expenses at home, such as cable TV or streaming movie services like Netflix;
  • Limit how often you eat out and meals at home;
  • If you have extra space in your home, consider roommate or renting it out on sites like Airbnb;
  • Cancel any memberships that are not being used, such as the gym;
  • Buy groceries in bulk to take advantage of discounts;
  • Carpool or use public transportation, whenever possible.

Learn more about saving for a down payment from our recent article titled "Saving for a Down Payment on a Home."

Seeking alternative ways to save for a down payment and committing yourself to a plan is more likely to be a better than borrowing from your 401(K). Keep in mind that all mortgage loan programs do not necessarily require a 20% down. For example, FHA loan programs allow for a down payment as little as 3.5%.

Always Double Check

Checking with your employer regarding taking money out from your 401(K) is a wise decision because not all 401(K)'s will have the same rules. You may also want to consult with your financial advisor, if you have one, to help you calculate the pros and cons of using your 401(K) as a down payment option, versus using an alternative method, such as the minimal down payment requirements of programs like FHA loan.

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