How to Use Your 401k to Buy a House

Buying a home is one of the biggest purchases you’ll make in your lifetime. If you’re like many homebuyers, you may not have abundant amounts of cash lying around to make a substantial down payment. However, the larger your down payment, the lower your monthly mortgage payments will be. For this reason, you might consider borrowing from your 401k for down payment funds.

Borrowing from Your 401k without Penalty

You may be wondering, how can I use my 401k to buy a house? There are two possible options: 401k withdrawals and 401k loans. Conventional wisdom advises against withdrawing funds from your 401k early. However, borrowing from yourself is different from withdrawing funds permanently and does not incur the same tax penalties as withdrawing funds.

Deciding whether it is a good idea to use your 401k to buy a house, you’ll likely want to borrow rather than withdraw money. In withdrawing from your 401k, you’ll have to pay income tax on the withdrawals and if you’re under 59 ½, you’ll incur a 10% penalty on the withdrawn funds.

In taking a 401k loan to purchase a home, you won’t incur the same penalties. If you fail to repay your loan within the allotted time frame, however, it will be treated as a taxable withdrawal.

Using a 401k Loan to Purchase a House

To avoid paying for mortgage insurance, you must make a downpayment of at least 20% of the purchase price of your home. If you have that money in a 401k, then a 401k loan is a feasible option for avoiding this added expense.

How Much of Your 401k Can Be Used for a Home Purchase

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.

Benefits of Borrowing from Your 401k to Buy a Home

The great thing about 401k loans is that they don’t count towards your debt-to-income ratio. Using a 401k loan to finance your down payment can put you in a more favorable position for financing your mortgage. And, these loans are not reported to the credit bureaus, so they don’t impact your credit score. It can also be beneficial to borrow from your 401k as a first time home buyer in order to make a higher down payment, especially in a competitive housing market. That said, you should consider the monthly payments on your 401k loan along with your monthly mortgage payment to ensure that these payments are within your budget.

How to Borrow from Your 401k Account

To borrow from your 401k loan to finance a down payment, you’ll need to talk to your employer’s benefits office or HR department, or with your 401k plan provider. You can also consult your plan document to find out if your plan permits borrowing from your 401k to purchase a home.

You’ll want to find out how much you’re able to borrow, the interest you’ll have to pay, and the repayment period. Additionally, ask about repayment options, such as whether your employer will deduct the monthly payment from your paycheck or if they will allow you to make 401k contributions while you pay back the loan.