Can First-Time Homebuyers Borrow From 401(k)s to Buy a House?
Buying
Traditional financial wisdom says that there’s never a good reason to borrow from your 401(k). It turns out that this isn’t always the case. First-time homebuyers might benefit from dipping into their 401(k)s to secure a down payment on their first home.
While it’s true that a 401(k) is a great investment, a home is often a better one, and it may be a smart way to speed up the home-buying process.
Using a 401(k) as a Down Payment
The benefit of using a 401(k) as a down payment is that there’s no unique penalty exemption for home purchases using a 401(k). That said, you will be charged a “hardship” exemption of 10% of the funds, and you’ll be required to pay income tax on anything you take out. Because of this, financial experts typically advise people who want to use this approach to roll their 401(k) over into an IRA before withdrawing any money. This allows first-time homebuyers to avoid paying the penalty and save a bit of money.
Keep in mind that, if you’re working for an employer who provides you with a 401(k), you won’t be able to roll it over. You may, however, be able to roll a 401(k) from a previous employer over. This will take some time.
If you prefer not to pull money out of your 401(k) directly, you can also borrow against it. The loan can typically be up to half the value of your 401(k) account, or $50,000 – whichever is less. While you have to pay back the loan, it’s often less expensive than simply withdrawing money from the account, and you won’t have to pay penalties or taxes on the amount you borrow.
The downside of the latter approach is that taking a loan against your 401(k) results in your incurring debt, and may have a negative impact on your debt-to-income score. This can negatively impact your ability to purchase a home. What’s more, the terms associated with these loans are typically very short (5 years or less). You may find the payments to be substantial on a large loan.
Should First-Time Homebuyers Use Your 401(K) To Pay For A Home?
While using a 401(k) to fund the down payment on a home can be a smart decision, it’s not for everyone. With that in mind, be sure to talk to a tax advisor or financial professional before you make the move. There may be other smart options that are wiser for your unique economic situation. For example, you could draw from your Roth or Traditional IRA or simply save up for the down payment.
Regardless of what you choose to do, planning to purchase your first home is an exciting time. Being prepared when it comes to your down payment is always a wise decision.
