If you’re saving for a new home, there may be some ways to access the money earlier than your retirement. By using the money in an employer-sponsored 401(k) plan or individual retirement account (IRA), it is possible to use these funds to finance your down payment and the closing costs on a house.
However, there are some things to keep in mind before using these funds. With a 401(k), you may be subject to taxes and penalties if you withdraw the money before you reach retirement age. With an IRA, you can take out up to $10,000 without penalty for a first-time home purchase, but you will still have to pay taxes on the money. In addition, if you have a large balance in your account, it may be affected by market fluctuations that could reduce its value.
401(k) Taxes and Penalties for Early Withdrawals
If you withdraw money from your 401(k) account before you reach age 59 1/2, you will generally have to pay a 10% early withdrawal penalty, as well as regular income taxes on the amount withdrawn. For example, if you withdraw $20,000 from your 401(k), you would owe $2,000 in penalties, plus whatever your income tax rate is on the amount. This can significantly reduce the amount of money you have available to use for a down payment.
Are there any ways to get around these 401(k) penalties? One way is to take a “hardship withdrawal.” This type of withdrawal is allowed in cases of financial need, such as medical expenses or the purchase of a primary residence. However, you will still have to pay income taxes on the money withdrawn. It’s also a bit complicated to get, but you could speak with your retirement account adviser about it.
During the pandemic, 401(k) withdrawals were allowed without penalties. But these protections have since been removed.
IRA Withdrawals for a First-Time Home Purchase
If you have an IRA, you can withdraw up to $10,000 without having to pay the 10% early withdrawal penalty. However, you will still have to pay regular income taxes on the money withdrawn. In addition, if you have a Roth IRA, you can only withdraw your contributions (not the earnings) without having to pay taxes or penalties.
If you have a small balance and you’re certain that you won’t need the money for retirement, it can be one option to finance your home purchase. Note that you’ll only be able to withdraw up to $10,000, though, which may not be enough for your entire down payment.
Some employers allow you to take a loan from your 401(k) for any reason, including to purchase a house. This means you could access the funds without incurring a tax penalty, as long as you stick to the terms of the loan and pay it back on schedule. If you have a solo 401k, you don’t even need permission.
But be aware this is a type of “piggyback” loan—a secondary loan that is intended for the purchase of a house. Lenders don’t look favorably upon this, would need to know about it in advance, and may deny the loan if you can’t afford it. To a lender, this type of 401k loan is just like credit card debt or student loans.
The Pros of Using a 401(k) to Buy a Home
The biggest advantage of using a 401(k) to buy a house is that you can access the money without having to go through a lender. In general, you can liquidate money in your 401(k) willingly within a matter of days. You’re in control. So, if you have a house that you really want, this can seem like an “easy” way to achieve your goals.
If you have a hefty 401(k), you could even consider purchasing a house in cash outright. You’d pay a lot in penalties and taxes for cashing out early, but you wouldn’t have to pay for a mortgage loan, mortgage origination fees, or other associated costs. You would have the peace of mind of owning your home outright.
The Cons of Using a 401(k) to Buy a Home
One of the biggest disadvantages of using a 401(k) to finance a home purchase is that you are taking money out of your retirement account. This means that you will have less money saved for retirement, which can impact your long-term financial security. And there are the above-mentioned taxes and penalties. You probably shouldn’t use a 401(k) to buy a home if it’s going to leave you reliant on social security.
In addition, if you take out a loan from your 401(k), you will have to pay interest on the loan. This can further reduce your retirement savings. If you leave your job (for any reason), you will generally have to repay the loan within 60 days or it will be treated as an early withdrawal and subject to taxes and penalties.
Will a Lender Let a Home Buyer Use Their 401(k) As a Down Payment?
A lender won’t have problems with you cashing out your 401(k) as a down payment. But a lender may have problems if you’re taking on a loan. If you’re taking on a loan that will cost $350 a month, then you need to have the debt-to-income ratio to support not only your home loan but also that loan. This can make you a much higher-risk borrower because now you have multiple loans to pay back.
Is a Home a Better Investment than a 401(k)?
On a broader level, some may wonder whether investing in real estate is better than investing in a 401(k). In general, if you want to buy a house, there is no right answer. But depending on your age, goals, and circumstances, investing in a 401(k) may be the better option for you. If you are younger and still have some time until retirement, putting as much money into your 401(k) as possible can help grow your nest egg.
If you’re closer to retirement, you may want to consider using a portion of your 401(k) to buy a house outright. This can give you some extra income in retirement and may help reduce your overall tax burden. You can also use a 401(k) for things like debt consolidation.
But this advice changes. For instance, if you’re in a very hot real estate market that’s just getting hotter, you could dramatically increase your net worth by buying now rather than socking away for retirement. If you’re in a cold market that isn’t appreciating much, though, compounding interest on your retirement account could be better.
If you are concerned about the amount of money required for a down payment, there are some low down payment options available. For example, some lenders offer options such as a 3% down payment or even 100% financing (if you qualify). This would let you purchase a property without hitting your retirement plan.
FHA loans require 3.5% down. If you don’t have 3.5% down, it’s possible that you just don’t have the buffer that you need to buy a house. VA loans require 0% down as do USDA loans, but they have unique qualifications. VA loans are only open to veterans and the immediate family of veterans, whereas USDA loans are only open to rural homes.
In addition, you can use grants and other types of assistance to help pay for your down payment. For example, some states offer down payment assistance programs. There are also non-profit organizations that can provide help with buying a home.
Using Your 401k Plan as “Cash Reserves”
Another option is to keep your retirement fund untouched and use it as “cash reserves” once you buy a house. This means that if you have an emergency fund, you can tap into your 401k instead of using credit cards or taking out a loan.
Most lenders require that you have six months of cash reserves. In other words, you need to be able to show that you can pay for six months of your mortgage if you lose your job.
So, even though you’re not cashing out your 401(k), it can still help. Your retirement accounts count toward your cash reserves because the bank assumes that you will take that money out if you’re in dire straits. Generally, it will only count for about 70% of the value (because the value of retirement accounts will fluctuate).
Getting an Equity Loan Against Your Retirement Account to Buy a Home
If you’re still set on using your retirement account to buy a house, you can get an equity loan against it. This is a unique type of loan that has actually become popular within the last few years.
Essentially, you’re taking out a loan that is guaranteed by the equity you have in your retirement account, rather than by your income. It’s something like a stated income loan, but it’s a fixed asset loan instead-it’s a non-traditional mortgage product.
If you have $1 million in the bank, for instance, it means that the bank will feel more confident in lending you $500,000 for a house. The bank uses your retirement account to secure the loan, but you don’t have to cash that money out. The bank just knows that you have the money to pay off the loan in full in the event that you need to.
It’s a unique mortgage product and it’s not feasible for most. You need a great credit score, for one. If you don’t have a lot of money in the bank, it isn’t going to be an option.
But if you do have a big retirement account that you don’t want to cash out, this can be a great way to leverage your equity into a property without the traditional fines and penalties. A lot of people do this to leverage themselves into an investment property.
Buying a House With a Self-Directed 401k
Now, this is a particularly uncommon thing—but it is something that can be done. If you have a self-directed 401k, you can purchase a house as an investment. A self-directed 401k is a special retirement fund that lets you invest in whatever you want.
But it does have to be an investment. You couldn’t purchase a primary residence with a 401k account in this fashion. You can purchase a rental property with a self-directed 401k, however, without a 401k withdrawal. That could give you the leverage for an investment property even if you have bad credit, on the basis of your 401k funds. The investment would essentially be part of your 401k account.
This is a pretty tricky thing to do; you would need to talk to your retirement planner.
Taking the Next Steps
If you are considering using these funds for a home purchase, it may be best to speak with a financial advisor or tax professional to determine what options are available to you and what steps to take to minimize the impact on your overall retirement savings. With careful planning and consideration, you could use your 401(k) or IRA to help finance your home purchase without negatively affecting your long-term financial goals.
Is it a good idea to use a 401k to buy a house?
It depends. On the one hand, using a 401k to buy a house can help you achieve your goals without having to go through a lender. If you’re just borrowing a down payment, using a 401(k) may be necessary to make it possible. On the other hand, it can reduce your retirement savings and may not be the best option in the long run. Ideally, it’s always best to use cash-but that might not be feasible.
Can I use my 401k to buy a house without penalty?
In some cases, it is possible to borrow money from your 401k without penalty. However, there are strict eligibility requirements and you will typically need to pay back the loan within a specific timeframe. Most banks are not going to look favorably upon this, either.
Can I use my 401k to buy a house without penalty during COVID?
The CARES Act allowed for penalty-free withdrawals from 401k accounts up to $100,000. But that provision has now passed. If you used it, you still owed taxes on the amount withdrawn but didn’t have to pay the additional 10% penalty.
What are the consequences of cashing out my 401k to buy a house?
Cashing out your 401k may have serious consequences. For starters, you will have to pay taxes on the amount withdrawn as well as a 10% penalty. This can significantly reduce the size of your nest egg. Additionally, cashing out your 401k permanently reduces the amount of money that you have available for retirement.