Can First Time Home Buyers Use 401k to Fund the Purchase?
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Here are some popular alternatives to using withdrawing money from a 401 to help buy a home. Today, except in extreme cases, buying a house with a 401 with retirement money is unnecessary. An exception to the limit is if 50% of the vested balance is less than $10,000, meaning the participant can borrow up to $10,000. However, individuals can borrow from a 401, but there are rules and limitations surrounding the loan amount and the term of the loan.
If your top priority is to prevent losing a lot of money, then you should consider going with the 401 loan. For example, if you withdraw $100,000 from your 401 before you reach age 59 1/2, you will pay $10,000 in early-withdrawal fees plus taxes. If you’re in the 24% tax bracket, that’s another $24,000 in federal taxes. The withdrawal is considered income, so you will pay federal and state taxes on the amount withdrawn. Another disadvantage for some people is the limit on how much you can borrow.
Is it a good idea to use a 401(k) loan to buy your first home?
The maximum loan amount that an individual can borrow is typically 50% of the vested account balance or a $50,000 maximum. A vested balance means it's the amount the participant owns of the money in the 401. If you take money out early, you incur a 10% early withdrawal penalty.
The other option is to take an outright withdrawal from your 401 fund. The reason it’s such an undesirable option is that you’ll automatically pay a 10% penalty on the funds you withdraw and you’ll pay income tax on top of it. That said, you don’t have to pay back the funds you withdraw. In certain circumstances, people may feel that this benefit outweighs the other financial penalties incurred.
Can You Use Your 401(k) as a First Time Home Buyer?
As the name suggests, you have to pay back a 401 home loan eventually, but as long as you follow the rules, the money you borrow is not taxable. That fact alone can make it a more affordable option than taking a 401 withdrawal for a home purchase. Keep in mind that youll be deducting mortgage interest on your taxes after you purchase your home. This may actually wash with some or all of the income you report from a retirement account withdrawal. Looking at your retirement account balance might make you feel as though you have more money than you actually have coming in on a regular basis. You’re still able to withdraw up to $10,000 for the purchase, repair, or remodel of a first home without paying a penalty, but you’ll have to pay regular income tax on the entire amount.
The following table can help you understand whether you can withdraw money without any penalty. Private mortgage insurance protects the lender, and it’s typically required if you’re putting less than 20% down on a conventional mortgage. Private mortgage insurance can be eliminated when you reach 20% equity in the home, but it can add to the cost of homeownership in the early years of your mortgage. Technically speaking, you can withdraw savings from almost any tax-advantaged retirement account to fund a first-time home down payment.
Retirement Account Withdrawal Comparison
If you meet the eligibility criteria, you can use your 401 funds to buy a home.
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However, this will add to your Debt-to-Income ratio, which may affect your mortgage conditions and eligibility. If you cannot get the money any other way, you may consider a piggyback loan that allows the borrower to get a partial loan for a down payment on top of the mortgage. On top of that, todays lowmortgage rates increase your home buying power by reducing monthly payments.Its easier to afford a home than ever before.
Many may look to their 401k to come up with the large sum required to buy a home. I borrowed from my 401k once some years ago to pay college tuition for one of my kids. As I paid down the loan I reckoned this was a not so good deal. I took cash out of a tax deferred account losing any tax deferred gains while the loan was outstanding.
So, before taking out a 401 loan, make sure your career is stable. You can typically borrow up to half of the vested balance of your 401k, or a maximum of $50,000. Most 401k loans must be repaid within five years, although some employers will allow you to repay a 401k loan over 15 years if it’s used for purchasing a home. Withdrawing or borrowing from your 401k is one way first-time home buyers can secure funding for down payments. While this may seem like an easy way to access funds, it’s not always the best option for buyers. Exploring alternative methods may be more beneficial in the long run.
Others understand that it’s a viable option for one-time lump sum costs, without the high interest that can come with a personal loan. The vested account balance is the total amount of money you’re eligible to keep if you leave your current employer. The money you’ve personally contributed is automatically added to your vested account balance. Your employer’s contributions are added once you’ve stayed with the company for a designated amount of time. A better alternative is to take advantage of first-time homebuyer programs that offer low down payment programs and even down payment assistance in some cases.
Before proceeding to collect money from different sources, check if your mortgage lender allows you to make a down payment of less than 20%. If your down payment is less than 20%, you get charged monthly Private Mortgage Insurance premiums until you own 20% of your home’s equity. Generally, paying for these premiums is better than taking money from your 401. While not all 401 plans allow for loans, if yours does, youre allowed to borrow up to 50% of your vested account balance or a maximum of $50,000, whichever is less. While withdrawing from a 401 is always considered a taxable event, depending on your age, theres a good chance that youll be taxed on the same money twice. To start, all 401 distributions are taxed as ordinary income.
Your second option would be to make a direct 401 withdrawal for your home purchase. Before diving into whether you should use your 401 to buy a house, it’s important to first have a firm grasp on how, exactly, a 401 retirement account works. Before liquidating some or all of your 401, check the first-time home buyer tax credits status. HomeReady is best for buyers with low- to moderate-income and average credit scores or better.
There are several reasons a first time home buyer may consider using 401 funds to pay for a new home. Going the loan route will also avoid the 10% early withdrawal penalty (given to anyone who withdraws funds before age 59½). It also won’t impact your credit report or your debt-to-income ratio, both significant benefits for people with low credit or who don’t want their credit affected for other reasons. However, unlike 401s, there is not a 10% penalty to withdraw money from an IRA to put toward a down payment on a home. That is true as long as the amount withdrawn does not exceed $10,000.
Start by getting pre-approved for a mortgage in just three minutes. Each post is edited and fact-checked by industry experts to ensure that we are providing accurate information for our readers. Shortlister Connect is a tool specifically designed to be utilized by the HR and Procurement/Sourcing teams within mid-size, large and jumbo employers. There are limitations on how many home buyers can lend or withdraw.
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