Can You Use a 401(k) to Buy a House?
While it is possible to use a 401(k) to buy a house, that financial decision is one that shouldn’t be taken lightly. Put simply, there are some expensive tax consequences to using a 401(k) to finance your down payment. Keep reading to learn what you need to know before going this route and what alternative options may be available to you instead.
Two ways to use a 401(k) to buy a house
Taking a 401(k) distribution
The first method you can use to borrow money from a 401k for a down payment is to withdraw money or take a distribution without intending to pay it back. Unfortunately, this method of using retirement funds to buy a house can have some expensive tax consequences.
While withdrawing from a 401(k) is always considered a taxable event, depending on your age, there’s a good chance that you’ll be taxed on the same money twice. To start, all 401(k) distributions are taxed as ordinary income. However, if you’re under the age of 59 ½, your withdrawal will be considered an early distribution and you’ll have to pay an additional 10% early withdrawal tax.
Using a 401(k) loan
Instead of withdrawing from a 401(k) for a house, it might be a better idea to use a 401(k) loan for your home purchase. As the name suggests, you have to pay back a 401(k) 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(k) withdrawal for a home purchase.
First, you have to pay attention to how much you can borrow. While not all 401(k) plans allow for loans, if yours does, you’re allowed to borrow up to 50% of your vested account balance or a maximum of $50,000, whichever is less.
Then, you’ll need to make sure that you’re repaying the loan properly. Traditionally, you must repay 401(k) loans over a period of five years — however, if you’re using the money to purchase your primary residence, that restriction is waived. In either case, though, you must make payments on the loan at least every quarter and each of the payments must be similar in size.
Pros and cons of using a 401(k) to buy a house
You’ll face fewer qualification requirements. With a traditional loan, you’d have to submit financial documents and go through an underwriting process, but borrowing money from a 401(k) is much easier. Typically, all you’d need to use a 401(k) to buy a house is your spouse’s consent.
You’ll likely get the money faster. Since you don’t have to go through an underwriting process in order to use a 401(k) loan for a down payment, the distribution of funds usually occurs much faster. That said, the exact time frame will depend on your plan, the plan’s administrator and whether you’ve chosen to receive money via check or direct deposit.
You’ll get to keep the interest. If you choose to borrow from your 401(k) for a house, you will still have to pay interest on the amount you’ve borrowed. The interest rate that’s charged will depend on your plan, but regardless of the rate, you get to keep the interest charges in your account.
You’ll likely receive a smaller paycheck. Many 401(k) loans are repaid through payroll deduction, which means that, if you do use a 401(k) loan for a house, your repayment will be taken out of your paycheck. In that case, you’ll need to carefully budget for your reduced income.
You might miss out on some retirement savings. Taking money out of your 401(k) for a house may mean having to put your 401(k) contributions on pause for a bit — some employers may prohibit new contributions to be made for a set period of time after a withdrawal.
You’ll need to consider the tax implications if you take a disbursement: Unless you’re almost retirement age, you’ll likely need to be OK with paying the extra 10% for taking an early distribution. That tax could make a huge difference in how much you’re able to put towards a down payment and how much you have saved for retirement.
Alternatives to using a 401(k) for a home purchase
Withdraw from your IRA
While using a 401(k) for a down payment may be costly at tax season, there’s a good chance you might have better luck taking a distribution from an IRA instead. In this case, the rules around distributions depend on what kind of IRA you have. For example, if you’re withdrawing from a Roth IRA, you can take a tax-free distribution at any time , provided that you’ve had the account for at least five years.
With a traditional IRA, however, the rules are a little bit different. Here, the tax scenario works similarly to a 401(k), where your distributions are taxed as ordinary income and you’re typically taxed on early withdrawals. However, there is an exception for first-time homebuyers: They are allowed to borrow up to $10,000 to put towards their down payment without having to pay the extra 10% early distribution tax.
Look into down payment assistance programs
If you don’t want to use a 401(k) for your down payment, you can always look into down payment assistance programs. These programs are meant to help buyers with low-to-moderate incomes shoulder the burden of paying their down payment and closing costs. Programs like these are typically available on a federal or state level, though sometimes they can be made available at the municipal level as well.
Often, the assistance will come in the form of a forgivable grant, a low-interest or deferred-payment loan or simply a second mortgage. However, each down payment assistance program is different, so if you’re thinking of going this route, your best bet is to talk to a lender in your area who can give you an overview of your options.
Ask for money from the seller
Whether or not you decide to pull from your 401(k) for your home purchase, if you truly feel that you’re unable to afford the upfront costs of buying a home, it may be a good idea to ask for money from the seller. In this scenario, the seller will pay for a portion of your closing costs upfront and raise the sale price of the home accordingly, which will allow you to pay for your closing cost overtime in the form of a slightly- higher mortgage payment.
While this may sound like a good deal, it’s important to note that it’s usually not recommended to go this route unless it’s absolutely necessary. Often, asking for a seller concession makes your offer appear weaker in the eyes of the seller and may make you less competitive in a hot market.
Get a gift from a loved one
Another alternative to using a 401(k) to buy a house is to ask for a gift from a loved one. Gift money can be used for a down payment as long as the lender can verify the source of the funds and the person giving the gift submits a statement that says the money is truly a gift and not a loan.
While parents typically give their children gifts, depending on your loan program, the gift may be able to come from another source. For instance, Fannie Mae allows gift funds to come from an immediate family member, fiancé or domestic partner, while the FHA’s list includes family members, employers, close friends and charitable organizations, as well as organizations or agencies providing homeownership assistance.
Save up over time
Lastly, you always have the option to save up for your down payment over time. While this option may take longer than some of the other ones on this list, it also comes with the least red tape. Once you know you have the money in your account, you’re free to spend it on a down payment without worrying about satisfying anyone else’s conditions. Plus, there are no repayment terms or contract negotiations to worry about.
If you’re going to use this method, it’s a good idea to set aside a dedicated bank account for your down payment funds. That way, you can easily keep track of your funds without worrying about accidentally spending them on another expense.
FAQs about using a 401(k) to buy a house
Can I use my 401(k) to buy a house?
The simple answer to the question “Can you use a 401(k) to buy a house?” is yes. It is possible to take money out of your 401(K) in order to cover your down payment on a house. However, be aware that you will be taxed on the funds. Distributions from your 401(k) are taxed as ordinary income and, if you’re under the age of 59 ½, you’ll also be taxed an extra 10% for taking an early distribution.
How does repayment work on a 401(k) loan?
Typically, you have five years to repay a 401(k) loan. However, if you’re using the loan to purchase a primary residence, that time frame may be extended. The exact time frame you’ll have for repayment will depend on your plan, but in some cases, it can last up to 25 years.
In either case, you must make payments on the loan at least quarterly and each payment must be of a similar size.
If I’m considering a 401(k) loan, what information should I get from my plan provider?
If you’re considering taking a loan from your 401(k), ask your plan administrator for the following information:
- Whether or not loans are/are not permitted
- The minimum dollar amount required to obtain a loan
- The maximum number of loans permitted by the plan
- The maximum dollar amount permitted
- The term of repayment (number of years)
- Any interest rate information
- Any required security for the loan
- How repayment may be made (for instance, payroll deduction)
- Any spousal consent requirements
Is there a 401(k) first-time homebuyer exemption?
Unfortunately, at this time, there is no such thing as a first-time homebuyer 401(k) withdrawal exception. While there is an IRA exemption that lets qualified, first-time homebuyers borrow up to $10,000 from an IRA without paying tax on the early deduction, this exemption does not currently exist for those borrowing from a 401(k).
If I don’t use my 401(k) to buy a house, when can I use my 401(k)?
Put simply, 401(k)s are meant to be retirement accounts, meaning that the money is ideally supposed to be used when you reach retirement age. The early withdrawal taxes that 401(k)s and IRAs use are supposed to incentivize you to leave the money untouched until you reach retirement age.
However, hardship withdrawals do exist to allow you to borrow money early under extenuating circumstances.