Posted 08/21/2017

by Gina Pogol

Gina Pogol writes about personal finance, credit, mortgages and real estate. She loves helping consumers understand complex and intimidating topics. She can be reached on Twitter at @GinaPogol.

Share This Page

As Seen On

Read This Before Borrowing From Your 401(k) To Purchase A Home

Should you use your 401(k) to fund a downpayment?

Gina Pogol

The Mortgage Reports Contributor

Should You Borrow From Your 401(k)?

Among first-time home buyers, “saving for a downpayment” is often cited as the number one obstacle to homeownership.

Sure, some households manage to put money aside each month into savings, but with each passing year, and as home values climb, the required downpayment size grows.

Oh, and don’t forget about closing costs.

Unless you're using seller concessions, closing costs can add another several thousand to your bottom-line and make it that much harder to have the money needed to buy a home.

This is one reason why buyers sometimes borrow from a 401(k) retirement plan.

When you borrow from a 401(k), you can get the money you want for a home in as little as a week and with nothing more than a phone call.

Plus, as you “pay yourself back”, you earn interest on your loan which can make the 401(k) withdrawal seem like a good deal. But, is it, really?

Here’s what to know when you want to borrow from your 401(k) retirement plan in order buy a home.

Verify your mortgage eligibility (Jun 18th, 2018)

What Is A 401(k) Retirement Plan?

A 401(k) plan is a special retirement program for U.S. employees. The program is sponsored by an employer, and allows employees to make pre-tax contributions to an investment plan.

This means that investments in a 401(k) “come off the top” of your income, before the government levies taxes.

Taxes, in other words, are only paid on what you don’t invest in a 401(k).

The program is named after the 1978 addition of section 401(k) to the U.S. federal tax code which allowed such pre-tax investments. Taxes on paid on 401(k) retirement plans at the time of withdrawal.

There are more than 50 million U.S. workers who are active participants in a 401(k) program.

Using 401(k) Money To Purchase A Home

When you invest in a retirement program, such as 401(k), there’s no rule to prevent you from withdrawing your money before you actually retire.

You may have a life emergency, for example, which demands the use of your retirement monies; or, you may need the money to make court-ordered payments.

These types of withdrawals are known as hardship withdrawals, and they come with a 10% tax penalty.

There’s also a provision which allows withdrawals to help with the purchase of a home. Rather than taking a hardship withdrawal, you can actually borrow funds from your 401(k) account with a promise to pay it back.

Arranging for a 401(k) loan can be quick. With just a phone call and some written notes to your plan’s administrator, money to purchase a home be wired to you in as little as a week.

However, just because you can borrow from your 401(k) to purchase a home, that doesn’t mean that you should.

Verify your mortgage eligibility (Jun 18th, 2018)

The Pitfalls Of Using 401(k) Money To Buy A Home

There are some “gotchas” when you borrow from a 401(k) to purchase a home which could raise your total loan costs to a figure much higher than what you borrow.

As one example, during the period your 401(k) loan is outstanding, you’re typically prevented from making full contributions to your existing retirement plan.

This means that you could forgo up to 5 years of retirement fund contributions, which could make a significant impact on you later in life.

And, to compound matters, if your employer is one that matches 401(k) contributions, you miss out on those contributions to your retirement plan as well.

However, the biggest risk to borrowing against your 401(k) is the one of unforeseen circumstances.

Should you borrow against your 401(k) and then leave the company for any reason — including being let go — you will have just 60 days to repay the entire remaining balance of your 401(k) loan.

If you’re unable to make that repayment, the remaining balance is considered a taxable withdrawal and is, therefore, subject to a 10% tax.

When you borrow from a 401(k) to purchase a home, then, one of the only ways to “beat the market” is to keep your job through the period of the loan, and hope that the stock market loses massive value throughout the 5-year term of your loan.

Borrowing from a 401(k) loan is a legitimate long-term risk.

Verify your mortgage eligibility (Jun 18th, 2018)

Why You Don’t Need To Borrow From Your 401(k)

When you borrow from a 401(k) to buy a home, the decision is based on the premise that a large downpayment is needed to purchase a home.

That premise is false. You don’t need to put 20% down to purchase a home.

In today’s mortgage market environment, there is a bevy of low- and no-downpayment mortgage options available which make it simpler to purchase a home than during any period this decade.

There are no fewer than 7 low-downpayment programs available to today’s home buyers. Nearly all are backed by the U.S. government, too, which means that they’re not going away soon.

  • The VA loan (Department of Veterans Affairs) allows 100% financing
  • The FHA loan (Federal Housing Administration) allows a 3.5% downpayment
  • The FHFA, which runs Fannie Mae and Freddie Mac, requires just 5% down
  • The HomeReady™ program (Fannie Mae) requires just 3% downpayment
  • The Conventional 97 loan (Fannie Mae) allows 3% down
  • The USDA loan (U.S. Department of Agriculture) requires 0% down
  • The Good Neighbor Next Door program (HUD) allows for a $100 down

The newest of these low- and no-downpayment programs is the HomeReady™ mortgage, which is the most flexible, allowing income from all members who live in a household; and, providing below-market mortgage rates to qualified borrowers.

You can read a complete HomeReady™ Q&A here.

With so many options to purchase a home with less than 20% down, then, there is often little need to borrow from a 401(k). When you borrow from a 401(k), you put yourself at risk.

What Are Today’s Mortgage Rates?

Mortgage rates are low, which makes for low mortgage payments. And, in many cities, now it’s less expensive to purchase than to rent.

Get today’s live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.

Verify your mortgage eligibility (Jun 18th, 2018)

Gina Pogol

The Mortgage Reports Contributor

Gina Pogol writes about personal finance, credit, mortgages and real estate. She loves helping consumers understand complex and intimidating topics. She can be reached on Twitter at @GinaPogol.

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.

3 Testimonials

Ron Z. Real Estate Agent

I am a full-time Realtor and I look forward to daily updates from The Mortgage Reports. The advice is useful and the insight is important. Thank you!

Stefan J.

The Mortgage Reports is invaluable. It's our primary source for information on housing finance.

Ricardo P. Project Manager

The Mortgage Reports is awesome. The site is extremely helpful, keeps you up-to-date, and puts you ahead of the game. Add The Mortgage Reports to your reading list!

2018 Conforming, FHA, & VA Loan Limits

Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)