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Can I Use My 401(k) To Buy a House?

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Home buyers can use their 401(k) retirement funds to make a downpayment on a home, but they shouldn’t. 401(k) loans are a relic from the 1980s and 1990s when low-down payment loans didn’t exist.

Borrowing from a 401(k) to buy a home is a last resort.

This in-depth article on 401k loans reviews how home buyers can borrow from a 401k for a down payment, why home buyers shouldn’t, and alternatives to consider.

Today, except in extreme cases, buying a house with a 401(k) with retirement money is unnecessary.

What Is A 401(k) Retirement Plan?

401(k) retirement plans are investment accounts with automatic tax breaks.

Congress made 401(k) plans possible when it passed the Revenue Act of 1978. The bi-partisan bill modified the Internal Revenue Code – Section 401(k) and eliminated taxes on deferred employee compensation. 

By 1981, the IRS changed its rules so employers could fund retirement plans, and today, more than half of U.S. workers participate in an employee-sponsored 401(k) retirement plan.

The IRS supports two 401(k) plan types:

  • Traditional 401(k): Contribute tax-free and pay taxes upon withdrawal.
  • Roth 401(k): Contribute taxed dollars and pay no taxes upon withdrawal. 

Employers typically provide a traditional 401(k) or a Roth 401(k) plan as part of an employee benefits package. 

How To Use Your 401(k) To Buy a House?

First-time home buyers can withdraw money from their 401(k) and use that cash for a downpayment.

Money withdrawn from a 401(k) isn’t free.

The IRS assesses a 10% penalty tax on amounts withdrawn for Americans not yet 59 ½, and taxes money withdrawn as annual income. 

The group makes 5 exceptions to its early withdrawal penalty:

  1. Expenses from “immediate and heavy” financial hardship
  2. Expenses linked to the birth or adoption of a child
  3. Expenses from unreimbursed medical bills
  4. Expenses related to total and permanent disability
  5. Downpayment on a home for first-time home buyers

In its list of exceptions, the IRS notes that first-time home buyers can use up to $10,000 from their 401(k) toward purchasing a home.

A bill in Congress, The Uplifting First-Time Home Buyers Act, proposes a doubling of penalty-free 401(k) withdrawals for buying a first home to $20,000. The bill is not yet passed into law.

401(k) withdrawals can be paid as cash or issued as a loan. 

What is a 401(k) Loan?

401(k) loans let employees borrow money from their 401(k) balances and pay that money back at an interest rate determined by the plan administrator.

Withdrawals are typically limited to 50% of the account’s total value, with a $50,000 limit. Loans must be repaid within 5 years and until the loan is paid-in-full, buyers may not make new 401(k) contributions.

What is a 401(k) Withdrawal?

A 401(k) withdrawal liquidates some or all of an employee’s retirement account and pays it out as cash. 

The employee is not obligated to repay or replace the cash withdrawn from the 401(k) account, but the IRS will recapture 10% of the amount withdrawn as part of the year’s federal tax filing. Money withdrawn may also count the withdrawal as taxable income.

Employees may continue to make 401(k) contributions after a withdrawal until annual contribution limits are reached.

Ask an accountant about the tax implications of withdrawing money from your 401(k) to make a down payment or purchase a home.

401(k) Loan vs 401(k) Withdrawal

Here is a head-to-head comparison showing the difference between 401(k1) loans and 401(k) withdrawals.

401(k) Loan401(k) Withdrawal
Repaid with interestNot repaid
Non-taxable incomeTaxable Income
No early withdrawal penalty10% early withdrawal penalty 
Contributions paused until loan is repaidContributions continue as-is
May be due with job changeNot affected with job change
Limited to 50%, not to exceed $50,000Limited to down payment and closing costs

Plan administrators enforce different 401(k) plan rules so ask your employer about your options. 

Should You Use Your 401(k) To Buy a House?

In general, home buyers should not use their 401(k) to help buy a home except as a last resort when:

  1. A low- or no-down payment mortgage is unavailable
  2. The down payment is too small to purchase a home

Even then, home buyers should investigate every available option before taking money from their 401(k) to fund the purchase of a home.

Taking money from your 401(k) is a high-cost transaction:

  • A tax is assessed on early withdrawal
  • A penalty fee may be charged on cash withdrawn
  • The tax advantages of investing are lost or reset permanently

When retirement account balances shrink, they provide less money for the future, which may extend a person’s working life by up to a decade.

Using a 401(k) to buy a home is rarely a good idea. Instead, buyers should look to low- and no down payment mortgages, and seek additional downpayment assistance for first-time home buyers, if necessary.

The cost of using a 401(k) to buy a home is too large.

Low Down Payment Alternatives To Using a 401(k) 

In the 1980s and 1990s, first-time home buyers used 401(k) plans to help buy homes because low- and no-downpayment mortgages were scarce.

Using a 401(k) to buy a home is not necessary today.

The government backs multiple low- and no-downpayment mortgage loans for first-time buyers, and the typical first-time home buyer doesn’t put twenty percent down.

Here are some popular alternatives to using withdrawing money from a 401(k) to help buy a home.

1. HomeReady

HomeReady is a 3-percent down mortgage backed by Fannie Mae. It provides subsidized, below-market mortgage rates to eligible buyers and allows downpayment funds to come from savings, cash gifts, and most other sources.

HomeReady is best for buyers with low- to moderate-income and below-average credit scores. 

Check your eligibility for a HomeReady loan.

2. Home Possible

Home Possible is Freddie Mac’s version of the 3-percent down mortgage. Like HomeReady, Home Possible gives below-market interest rates to eligible buyers, and offers reduced mortgage insurance rates.

HomeReady is best for buyers with low- to moderate-income and average credit scores or better. 

Check your eligibility for a Home Possible mortgage.

3. Conventional 97

Conventional 97 is a branded name for Fannie Mae’s and Freddie Mac’s standard 97 loan-to-value mortgage loan. Conventional 97 requires buyers to make a three percent downpayment and complete an online homeownership education course before closing.

Conventional 97 is best for buyers with decent credit scores who borrow within conforming mortgage loan limits. 

Check your eligibility for a Conventional 97 loan.

4. FHA Mortgages

FHA mortgages are the original low-down payment mortgage. Since 1934, FHA mortgages allow 3.5% down payments for buyers of all credit types and incomes. FHA mortgages are best for home buyers with average credit scores or below and buyers of multi-unit homes. 

Check your eligibility for an FHA mortgage.

5. VA Mortgages

VA mortgages are mortgages backed by the Department of Veterans Affairs. Established as part of the G.I. Bill in 1944, VA loans allow 100% financing with no mortgage insurance and at low-interest rates. VA loans are limited to active duty military, veterans, and surviving spouses. 

Check your eligibility for VA mortgages.

6. USDA Mortgages

USDA mortgages are mortgages backed by the U.S. Department of Agriculture. USDA loans allow buyers of modest means to purchase homes in less-dense parts of the country with no money down. USDA mortgage rates are subsidized, and mortgage insurance rates are reduced. USDA loans are best for low- and moderate-income home buyers in suburban and rural locales.

Check your eligibility for a USDA loan.

7. First-Time Home Buyer Programs

Federal, state, and local governments make downpayment assistance programs, tax credits, and cash grants for first-time buyers. In addition, Congress is considering multiple programs to make it easier for first-time buyers to fund a downpayment and purchase a home.

Before liquidating some or all of your 401(k), check the first-time home buyer tax credits status

Our Advice – 401(k) loans are your last resort

You don’t need to take money from your retirement to fund your first home purchase. Low- and no-downpayment mortgage options are safer, less expensive, and lower risk.

Before cashing out your 401(k), check your other options. 

Start by getting pre-approved for a mortgage in just three minutes.

Happy homebuying.

Get pre-approved for a mortgage today.

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