The question of using 401k to buy a house is becoming quite common among many readers.
It turns out that many people are considering using their retirement savings for the down-payment funds; maybe it is a trend in the current times.
Simply put, it is possible using 401k to buy a house to help cater for the down-payment.
You might, however, be required to shell out for the penalties and taxes upon an early withdrawal from your 401k account.
You thus must consider the advantages and disadvantages of doing this.
You should also know the exact amount you would be expected to pay as penalties. This amount differs per account, and you can get yours by reviewing the fine print in your account’s paperwork.
Read: What to Look for When Buying a House
Using 401k Withdrawal to Buy a House
It is easy to withdraw money from your 401k account to take care of the cost of a down payment. In any case, the money is yours.
However, an account like the 401k has been developed to encourage long-term savings and put you off from making early withdrawals.
Because of this, it is highly likely that you will pay a penalty for making a withdrawal from your 401k account early for whatever reason.
‘Hardship withdrawals’ are allowed under the IRS, in some situations.
If you intend to spend the money to cater for the down payment of a house which will serve as your main residence, then this qualifies as a hardship withdrawal.
You, however, may still need to pay income taxes, including a penalty for such a withdrawal.
Before using 401k to buy a house, check out the IRS rules for this specific case before you proceed.
Using 401k Loan to Buy a House
In case your plan rules permit loans, your account could help you in buying a real estate property.
It is possible to borrow $50,000 or half of your savings, whichever is lower, as well as all the outstanding unpaid loans.
Unless your loan can finance your primary home, you will be expected to pay it back in five years to ensure it remains an untaxed loan.
When a 401k loan is used to purchase a primary home, then it can be paid back over a longer time, as long as 15 years, depending on your plan.
The amount you pay in interest is included in your 401k account but is not put as an itemized deduction on your tax return.
A 401(k) Loan or 401(k) Withdrawal, Which is Better?
When using 401k to buy a house, you have the option of making a withdrawal or taking a loan.
Which is better?
Thinking about the possible taxation that you will be expected to pay from an early withdrawal, a 401 (k) loan could be the better option.
Also Read: How to Pay Less Tax Legally
This is more so if the interest you will end up repaying is less than what you would pay as tax.
Either way, diminishing your retirement savings is one disadvantage that comes with both options.
When you have a 401k loan, you can replace that amount with time.
However, in case you are drawing out an old 401(k) account, you cannot put back the money.
In either case, you tend to lose the power of compound interest to raise your retirement money with time.
An advantage of using 401k to buy a house, either as a withdrawal or as a loan, is that it could make it possible for you not to pay private mortgage insurance.
This happens when you offer the lender a down payment that is large enough.
Private mortgage insurance is the insurance used to cover the lender, and it is needed if you intend to put down less than 20%.
In this case, you will need to pay an upfront coverage premium plus a monthly premium that is then included in your mortgage payment.
If you get to 20% equity in the home, the private mortgage insurance could be eliminated, but it could add to homeownership cost in your mortgage early years.
So, Should You Consider Using a 401k Loan to Buy a House?
These are the questions that I normally say do not have a black and white answer.
It is clearly a personal choice, but it is important for you to consider all possible factors before you reach a decision.
Discussed below are some key points you should think about before you decide on using 401k loan to buy a house.
What return on investment are you likely to forego?
The money you happen to borrow from your 401k account definitely does not exist in your retirement account anymore.
With an opportunity at a return on your investment, you may end up missing on long years of investment advancement for every year you will be expected to pay the loan back.
Do you qualify for the mortgage without the loan?
It may not be advisable to strain yourself using a 401(k) so as to acquire a mortgage that could be more than you can afford.
You may end up having problems paying the loan, which could lead you in a bad position financially.
Does the loan enable you to eliminate your need for private mortgage insurance or qualify for a lower interest rate on your mortgage?
In case you are able to save money with time by not having to pay private mortgage insurance or through paying lower interest rates, such a home loan sounds great.
Either way, calculate the amount based on your specific situation, and when you are faced with uncertainty, reach out to a financial planner to help you in doing the math.
It is always good to seek advice when in doubt, rather than doing things the wrong way hence hurting your future financial prospects.
Read: Average Balance in 401k: Retirement Savings Plan
Alternatives to Using 401k to Buy a House
Down Payment Assistance Programs
Such programs aim at helping suitable buyers in meeting their down payment and closing costs.
There are programs that give grants to buyers that qualify, and these grants do not have to be paid back.
There are also those that offer matching savings programs (which is similar to a 401k, that match each dollar you save for your down payment to a specific amount.
Help from Family
Gifts from family members can also help you come up with money that is enough to cater for a down payment.
Consult your lender on the documentation needed for down payment funds that you get in the form of gifts.
Wait and Save
It is possible that you desire to purchase a house right away, but it may be advisable to wait until you have saved up enough to cater for a down payment to prevent you from having to borrow more money.
Go through your budget to see whether there are things you can do without in bid to reduce the expenditure.
Earning extra income is something else you can think of so as to save more and in a reduced period of time.
As I normally say, there’s a limit to how much you can cut, but there is no limit to how much you can earn.
In as much as we are always aiming at cutting costs on matters finance, more focus should be on how you can increase your income.
That is where you will actualize the financial freedom that you crave.
Also Read: How To Make More Money
In case you have an IRA, it is possible for you to withdraw as much as $10,000 to aid in a down payment for a home, without having to suffer the 10% early withdrawal penalty.
Nevertheless, it is important to note that if you happen to be making a withdrawal from a traditional IRA, you will still be expected to pay income tax on the amount that you are withdrawing.
In conclusion, using 401k to buy a house is an option, though there are other alternatives to this. It is upon you to decide which option suits you the best.