Yes, you can tap into your 401(k) to buy a house, but it’s not something to jump into lightly. There are some real trade-offs you should weigh first. Here’s a quick breakdown to help you figure out if it’s the right move for you:
What’s the difference between withdrawing from my 401(k) and taking a 401(k) loan?
- Withdrawing from your 401(k):
- Penalties and taxes: Pulling money from your 401(k) before you’re 59½ comes with a 10% early withdrawal penalty, plus income taxes. For example, if you withdraw $20,000, you might face a $2,000 penalty and owe income tax on the amount, reducing your funds significantly.
- Retirement impact: Taking out money now means less growth for your retirement savings. The money you withdraw misses out on potential investment growth, which can be a big hit to your future financial security.
- 401(k) loan:
- Borrowing vs. withdrawing: A 401(k) loan lets you borrow up to $50,000 or 50% of your vested balance, whichever is lower, without the penalties of an early withdrawal. However, you’ll need to repay it with interest, typically within five years, though this can be extended if the loan is for buying your primary residence.
- Repayment risks: If you leave your job or fail to repay the loan, the remaining balance could be treated as a distribution. This could trigger taxes and penalties, complicating your financial situation.
Why shouldn’t I rely on my 401(k) for home buying?
- Financial penalties: Withdrawing funds from your 401(k) comes with steep penalties and taxes. This can significantly reduce the amount you have available for your home purchase and other expenses.
- Retirement sacrifice: Using retirement funds for a home purchase might seem tempting, but it could undermine your long-term financial goals. Your 401(k) is designed to grow over time, and taking money out now reduces that growth potential.
- Loan repayment concerns: If you opt for a 401(k) loan, it’s crucial to have a solid plan for repayment. Missing payments or leaving your job can lead to unexpected taxes and penalties.
If I use my 401(k) to buy a home, will I get an FHA loan or a conventional loan?
The type of loan you get—FHA or conventional—isn’t directly influenced by how you fund your down payment. Both types have their criteria:
- FHA loan: Ideal for those with lower credit scores, high DTI ratios, or smaller down payments. It’s often a good choice for first-time buyers needing more flexibility. Using your 401(k) funds for an FHA loan can help meet the down payment requirements.
- Conventional loan: Suitable for those with stronger credit scores and larger down payments. Your 401(k) funds can help with the down payment, but approval will depend on your overall financial health and creditworthiness.
Scenario comparison: Borrowing from your 401(k) vs. keeping your money in the 401(k)
Scenario 1: Borrowing from your 401(k)
- Home price: $400,000
- Down payment from 401(k): $80,000 (20%)
- 401(k) loan interest rate: 5%
- Mortgage rate: 6%
- Loan term: 30 years
- Annual return on 401(k): 7%
Impact on 401(k) and mortgage:
- 401(k) loan repayment: Monthly payment of about $427.37, total repayment of about $154,058.
- Home mortgage: Monthly payment of about $1,918.45, total repayment of about $690,626.
Opportunity cost: If you left $80,000 in the 401(k) growing at 7% annually, it could grow to about $1,583,000 over 30 years.
Scenario 2: Keeping your money in the 401(k) and saving for a home
- Home price in 5 years: Expected to rise to $425,000
- 401(k) balance: $80,000 growing at 7% annually
- Down payment for home in 5 years: 20% of $425,000 = $85,000
Impact of keeping 401(k) investments:
- 401(k) growth: Future value of $80,000 grows to about $112,500, giving you an extra $32,500.
- Home purchase: With an $85,000 down payment, you’d need a $340,000 mortgage. Monthly payment of about $2,044.78, total repayment of about $737,000.
Opportunity cost: Waiting 5 years means missing immediate home equity build-up but benefiting from continued 401(k) growth.
So, what’s the best way to get a down payment?
Borrowing from your 401(k) provides immediate benefits but comes with long-term costs, including loan repayment and lost investment growth. Keeping your money in the 401(k) allows for continued growth and secures your retirement future, though it might mean waiting longer to purchase a home and facing potentially higher home prices and mortgage rates.
And you have other options!
- Local down payment assistance programs.
- Liquidating stocks, which can be less expensive and simpler
- Gift funds from family members to help with the down payment, if that’s a possibility
Keep in mind that each 401(k) plan has its own rules about withdrawals, so it’s smart to review those before making a decision.
Finally, remember that 20% down isn’t necessary—and it’s often not the best financial decision.
And if you’re feeling uncertain, don’t hesitate to talk to a lender who can help you navigate these complex dynamics. Give us a call at 737-510-2523
If you’re ready to start your journey to homeownership, get pre approved with Tomo Mortgage today.
