If you are coming up short on your down payment for a home, but you have a funded 401k account, you may be able to use your retirement funds towards your down payment. There are strict rules you must follow in order to use your retirement funds. If you follow them, though, it could be a good way to get the house you want.
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The 401k Withdrawal
If you are less than 59 ½ years old, you may face a little difficulty withdrawing your funds. Your first step should be to check with your employer’s HR department to see if it’s allowed. If they do allow it, you’ll have to meet the following requirements.
Some employers only allow you to withdraw from your 401k if you are experiencing a financial hardship. If you are, though, buying a home might not fit within the guidelines. However, if you have a 401k with a previous employer that you didn’t roll over, you may be able to withdraw from it.
If you do use the funds from an old employer, you will have to pay taxes and a 10% penalty on the use of the funds. The IRS tries to dissuade you from using the funds for anything except retirement, which is why you’ll pay the 10% penalty. You pay the taxes because you were able to invest the money in your 401k before taxes. Since you are withdrawing the funds now, you will owe the taxes.
The 401k Loan
You also have the option to take a 401k loan, which is the easier option between the two. As the name suggests, a 401k loan must be repaid Yes, you are repaying yourself, but you must pay it back and with interest. Your employer may dictate how much you can borrow. If they don’t, the IRS does. You can borrow the lesser of:
- 50% of the amount you have vested in your account
You typically have 5 years to repay the 401k loan. You don’t have to make monthly payments like a regular loan, though. At a minimum, you must make quarterly payments. Your payments must include principal and interest.
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Your lender may include the payment for the 401k loan in your debt ratio. It depends on the loan program and the lender’s requirements.
One note of caution with the 401k loan, though. If you leave your job before you repay the loan, it becomes due and payable immediately or within the near future. If you miss the deadline, the IRS treats it as a full distribution. You will then owe taxes and the 10% penalty on the full amount.
Which Option is Right?
At first glance, the 401k loan seems to make more sense. You don’t pay any taxes or penalties for borrowing the money. But you do pay interest, so pay close attention to how much the interest will cost you. In addition, you should consider your long-term plans. Are you going to stay at the job or is this a short-term position for you? If you know you’ll leave, you must make sure that you can afford to pay the loan back in full. If you won’t be able to do that, the 401k withdrawal may make more sense.
Do You Need to Use Your 401k Funds?
Before you withdraw from your 401k account, be certain that you need the funds. There are several programs available today that don’t require a large down payment. The FHA loan is one option, as it only requires a 3.5% down payment. You can even obtain 100% of the funds as gift funds to help alleviate the stress of saving the money. Even the conventional loan has the option to put down just 5% of the purchase price of the home.
Think carefully about the consequences of withdrawing or borrowing funds from your 401k. In some cases, it’s the only way to get a home. If that’s the case, determine which option has the fewest consequences to help you stay financially strong after buying a home.