First-time home buyers can buy a house with a 401(k) retirement plan but it’s generally a bad idea. Here’s why: 401(k) loans are relics when low-down payment mortgages didn’t exist.
Except in extreme cases, buying a house with 401(k) retirement money should be a last resort.
How The 401(k) Retirement Plan Works
401(k) retirement plans are investment accounts with automatic tax breaks.
Congress made 401(k) plans possible in the Revenue Act of 1978. The bi-partisan bill modified the Internal Revenue Code Section 401(k) to eliminate 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.
401(k) Withdrawals Are A Last Resort
According to the IRS, first-time home buyers cannot withdraw up to $10,000 penalty-free from their 401(k) to purchase a home.
Home buyers should not use their 401(k) to help buy a home except as a last resort, when one of two conditions are true:
- The buyer does not qualify for a low-downpayment mortgage
- The buyer needs a larger down payment to qualify for a mortgage
Even then, home buyers should investigate every available option before taking money from their 401(k) to fund the purchase of a home because taking money from a 401(k) is a high-cost, high-risk transaction.
If using a 401(k) loan to buy a home is necessary, there are two types of withdrawals: 401k loans and 401k withdrawals. Consult with an accountant about the tax implications of each path.
The 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.
The 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The employee is not obligated to repay or replace the cash withdrawn from the 401(k) account, but the IRS will recapture 10% of the amount withdrawn as part of the year’s federal tax filing.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.
401(k) Loan vs 401(k) Withdrawal
| 401(k) Loan |
401(k) Withdrawal |
| Repaid with interest |
Not repaid |
| Non-taxable income |
Taxable Income |
| No early withdrawal penalty |
10% early withdrawal penalty |
| Contributions paused until loan is repaid |
Contributions continue as-is |
| May be due with job change |
Not affected with job change |
| Limited to 50%, not to exceed $50,000 |
Limited to down payment and closing costs |
Low Down Payment Alternatives To Using a 401(k)
Using a 401(k) to buy a home is unnecessary for most first-time buyers. Most mortgage companies allow low- and no-downpayment mortgage loans, and the typical first-time home buyer rarely makes a large down payment anyway.
Here are some popular mortgage alternatives to raiding a 401(k):
Conventional 100
The Conventional 100 mortgage is a first-time home buyer mortgage that requires no money down and offers discounted interest rates and mortgage insurance premiums. The program is limited to 1-unit homes, including standalone homes, townhomes, and condominiums. Eligible buyers must have average credit scores or better.
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.
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.
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.
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.
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.
USDA Mortgages
USDA mortgages are mortgages backed by the U.S. Department of Agriculture. USDA loans allow buyers to purchase homes in the USDA eligibility map with no money down. USDA mortgage rates are subsidized, and mortgage insurance rates are reduced.
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.
See all available first-time home buyer grants and programs.
