Key points
- You can use your 401(k) to buy a home through a loan or withdrawal.
- You can borrow up to 50% of your vested balance or $50,000, whichever is less, tax-free.
- The more money you take out of your 401(k), the less money you have invested for retirement.
Homeownership is a goal for many Americans. But it can be hard to achieve.
In an ideal world, you’d have enough savings to pay for a down payment on your dream home. That isn’t always the case, however. One option if you’re short on funds is using your 401(k) to buy a house.
Although it may be a quick path to cash when you need it, tapping your 401(k) early can have dire consequences down the line.
How can I use my 401(k) to buy a home?
There are two primary ways to use your 401(k) to buy a home: 401(k) loans and 401(k) withdrawals. While either option can be effective, rules abound, so make sure you understand them.
401(k) loan
The first method for using your 401(k) to buy a house is through a 401(k) loan.
Not all plans permit loans, so check with your employer before pursuing this option.
If your plan allows you to take a loan, you typically can borrow up to 50% of your vested balance or $50,000, whichever is less. If your vested balance is under $20,000, however, you can borrow up to $10,000.
You can have multiple outstanding loans from your plan. But the total balance cannot exceed the maximum amount allowed based on your vested balance.
You typically have five years to repay a 401(k) loan. The IRS provides an exception to this requirement, however, if the loan is used to purchase a primary residence. The time frame for repayment is determined by your plan.
You must repay the principal plus interest in substantially equal payments at least quarterly. These repayments are not contributions. And some plans don’t allow you to make contributions while you have an outstanding loan.
Your plan can suspend repayments for up to a year if you take a leave of absence or enter military service. But you are still required to repay the loan within the agreed-upon term. Once you return, you must either increase your payments or make a lump-sum payment.
You won’t owe income taxes on the loan amount as long as you repay it on time. A loan that is not repaid on time is considered a distribution and may trigger both taxes and penalties.
“Always remember that you are borrowing your own money and the principal and interest due are going back into your account,” said Michael Bartolotta, a financial advisor at Kuttin Wealth Management, a private wealth advisory practice of Ameriprise Financial Services.
Yes, you’re repaying yourself. But in the meantime, you’re also missing out on investment returns on the money you borrowed.
401(k) withdrawal
The second way you can use your 401(k) to buy a home is through a hardship withdrawal.
Depending on your plan, you may be able to take a hardship withdrawal to cover costs directly related to the purchase of your primary residence. It is limited to the amount necessary to satisfy the need.
You will owe ordinary income taxes on a hardship withdrawal. It may also be subject to a 10% penalty on early distributions. These taxes and penalties eat into the amount you receive, which is one reason many advisors caution against such withdrawals.
“A good rule of thumb is 35% to 40% of the gross withdrawal will go toward tax and penalties,” said Ryan Shuchman, investment advisor representative and senior partner at Cornerstone Financial Services.
Withdrawals have benefits over loans.
“You are not subject to any repayment schedules or employment requirements, and you can still make contributions to your account,” Bartolotta said.
But the end result is still less money in your 401(k) going toward your retirement savings.
Pros and cons of using a 401(k) to buy a home
Using your 401(k) to buy a home can be tempting and may seem like “the path of least resistance,” said Eric Szczurowski, a private wealth advisor at Kuttin Wealth Management.
But that’s often only if you don’t “go in with your eyes wide open,” Szczurowski said. Once you understand the pros and cons of using your 401(k) to buy a home, you may decide it isn’t a great option.
Pros
- No credit requirements. Unlike getting a traditional loan from a lender, you don’t have to meet credit requirements to take money out of your 401(k).
- No impact on credit score. Taking money from your 401(k) won’t impact your credit score.
- Potentially lower interest rates. 401(k) loans may have lower interest rates than traditional loans from third-party lenders. Plus, the interest you pay goes back into your account.
Cons
- Taxes and penalties. Income taxes and early withdrawal penalties can reduce the amount you receive from a 401(k) withdrawal.
- Loan repayment costs. You must make your 401(k) loan repayments in addition to your monthly home payments.
- Less money for retirement. Any money you take out of your 401(k) reduces the amount you have invested for retirement. Even if you repay it, you lose the potential growth while it isn’t invested.
Alternatives to using your 401(k) to buy a house
Several alternatives could help you achieve your homeownership dream without sacrificing your retirement preparedness.
Savings
“The time-tested and most-recommended approach is a steady savings methodology,” Shuchman said. He suggested putting aside money for your future down payment in a high-interest savings account or money market fund.
Mortgage programs
There are several mortgage programs designed to help Americans struggling to purchase a home. The Federal Housing Administration and Department of Veterans Affairs offer mortgages with low down payments and flexible income and credit guidelines. The Department of Agriculture also provides assistance for low-income and very-low-income homebuyers, including loans that require no down payments.
You can see if your state has additional programs on the Department of Housing and Urban Development’s website.
Your IRA
IRAs allow you to withdraw money for a first-time home purchase. Unlike with a 401(k), these funds are not subject to the 10% early withdrawal penalty. But remember that you are limited to $10,000.
Just because you can borrow from a 401(k), should you?
“Although borrowing from a 401(k) is an option, it doesn’t mean you should,” Szczurowski said, adding that protecting your financial health is “paramount.”
While you can borrow money to buy a house, you cannot borrow money to fund your retirement. Taking funds out of your 401(k) today puts your retirement at risk, potentially leading to an even bigger financial burden than the cost of purchasing a home.
“It’s important to carefully evaluate the potential impact on retirement savings, tax implications and repayment challenges before tapping into your 401(k) for a home purchase,” Szczurowski said.
Consider meeting with a financial planner and tax professional before committing to this strategy so you can be sure it makes sense for you.
Frequently asked questions (FAQs)
You can withdraw money from your 401(k) without penalty in certain circumstances. Here are some examples:
- You reach age 59½.
- You are totally and permanently disabled.
- You take a series of substantially equal periodic payments.
- You pay for unreimbursed medical expenses up to a percentage of adjusted gross income.
- You are a qualified military reservist called to active duty.
- You leave your employer during or after the year you reach age 55, or 50 for public service employees.
Borrowing from your 401(k) is often not worth the long-term consequences.
“Saving for retirement is critical, and borrowing or withdrawing from a 401(k) often sets retirement road maps back substantially,” Shuchman said.
You generally can borrow up to 50% of your vested 401(k) balance or $50,000, whichever is less. If your vested balance is under $20,000, you can borrow up to $10,000.
You can take a hardship distribution to cover costs directly related to the purchase of your primary residence. The amount is limited to that which is necessary to satisfy the need.
