You can use a 401k for a down payment by taking either a 401k loan or making a 401k withdrawal. However, this is usually not a good idea. It could cost you a steep withdrawal penalty, not to mention diminish your retirement savings in the long run.
Buying a home can be stressful, especially if it’s a seller’s market or inflation is rampant. Many people are struggling to figure out how much their down payments should be and how to finance them.
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broker Jerry
is committed to helping you save money and use it wisely. Here’s what you need to know about using a 401k for a home down payment. What is a 401k?
A 401k is a type of retirement savings account that doesn’t cost you tax when you put money into it, but when you withdraw from it. You are limited to putting a certain amount each year, but that will change based on the current market.
Some employers may match your 401k contributions, incentivizing you to save even more.
You are usually allowed to withdraw from your 401k once you turn 59 ½ or are 55 and unemployed.
Can you use your 401k for a down payment?
You can use funds from your 401k to make a down payment happen, but this is never recommended. It’s best to pull from your 401k prematurely only as a last resort.
Still, you have two possible options to get money from your 401k to buy a house: a 401k loan and a 401k withdrawal.
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Using a 401k loan for a down payment
Your first option is to take out a 401k loan, which allows you to take funds from your account and pay them back with interest. You can only take out up to $50,000 or 50% of your vested account balance, whichever is the smaller amount.
This option is the better of the two because there’s no withdrawal penalty, but the interest (1-2%) will cost you.
You’ll normally have to repay all the funds within five years—for a $50,000 loan, that’s something like $10,000 plus $100-$200 in interest back each year. If you’re buying your primary residence, however, you may be allowed a longer loan term.
There are a few downsides to 401k loans, however. You may not be able to contribute new funds to your 401k while paying off a 401k loan. Your employer may also be barred from matching your paycheck contributions even if you can still make them.
What’s worse: if you lose or leave your job, the entire loan amount would be due at the next tax date, sometimes leaving you with less than a year to redeposit all the funds.
It’s likely that taking out this loan won’t harm your credit score, but mortgage lenders may see it as increased debt in your debt-to-income ratio and make it more difficult for you to secure a mortgage.
Key Takeaway You can take out a 401k loan up to $50,000 or 50% of your vested balance to pay for a down payment, but you’ll have to repay the funds with interest. You may not be able to contribute new funds to your 401k while you’re paying back the loan.
Withdrawing from your 401k for a down payment
Your other option is to withdraw directly from your 401k. Wait, didn’t we just say you can’t withdraw until you’re 59 ½ or 55 in some circumstances? Well, you technically can withdraw your 401k funds at any time (it is your money, after all)—but for a steep penalty of 10% of the total withdrawal amount.
This penalty fee is in play unless you fall into a specific set of exemption circumstances. You’d need to check with your financial institution.
In cases of financial hardship or to make a big purchase, like needing to close on a home while paying significant medical bills you’re allowed to withdraw as much as you need for the payment(s) and no more. You’ll need to prove that you need the funds by showing income and bill statements.
Why it’s not a good idea to use 401k for a down payment
Each option for using your 401k money to make a down payment comes with significant drawbacks. The biggest is obviously the hefty penalty fee associated with withdrawing money outright.
Taking money out of your 401k won’t just cost you extra in the short run—it will also limit your financial growth in the long run. This is because you typically get an annual return (like interest) proportional to the funds sitting in your account: let’s be generous and say this is 7%.
Cutting a $100,000 401k in half for a $50,000 down payment means you’ll only get $3,500 (0.07 x 50,000) instead of $7,000 in extra funds via the annual return, giving you less and less to spend in the future.
Alternatives to using your 401k for a home down payment
You may be feeling stuck now that you’ve realized using your 401k isn’t a great option to put that new home within reach. But don’t worry—you have some other, less costly options.
First, consider withdrawing from your IRA/Roth IRA instead. IRAs (another type of retirement account) are preferable because they’re not subject to tax at withdrawal. IRAs may also offer special provisions if you have never owned a home before or haven’t in the last two years.
The offer would work like this: you can withdraw up to $10,000 to use exclusively for buying a home. If you don’t misuse the funds, you won’t be subject to the 10% withdrawal penalty.
If you don’t have an IRA, consider finding a low or no down payment mortgage. Options include FHA loans, Conventional 97 loans, VA loans for veterans, and HomeReady and HomePossible loans. (Just don’t agree to pay insanely high interest in exchange for a low down payment.)
If you’re really stuck, reach out to a relative, friend, or community non-profit to get payment assistance.
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