Should You Use a 401(k) Loan to Buy a House?
Buying a house is a big financial decision that requires a lot of savings and planning. One of the challenges that many homebuyers face is coming up with enough money for a down payment. If you have a 401(k) retirement plan, you might be wondering if you can use it to help you buy a house.
A 401(k) is a type of employer-sponsored retirement account that allows you to save money for your future with tax benefits. You can contribute a portion of your pre-tax income to your 401(k), and your employer may also match some or all of your contributions. The money in your 401(k) grows tax-deferred until you withdraw it in retirement.
However, you can also access your 401(k) money before retirement by taking out a loan or making a withdrawal. Both options have pros and cons, and they may affect your retirement savings and tax situation. In this article, we will explain how you can use a 401(k) loan or withdrawal to buy a house, and what are the advantages and disadvantages of each option.
How to Use a 401(k) Loan to Buy a House
A 401(k) loan is one way to use your retirement savings to buy a house. A 401(k) loan allows you to borrow money from your own account, up to a certain limit. You do not have to pay any taxes or penalties on the loan amount, as long as you repay it within the specified term. You also pay interest on the loan, but the interest goes back to your own account.
The Internal Revenue Service (IRS) limits 401(k) loans to the lesser of $10,000 or 50% of your vested account balance, or $50,000, whichever is less . For example, if your account balance is $50,000 and you are fully vested, the maximum amount you can borrow is $25,000. A 401(k) loan must be repaid within five years , unless it is used to buy your primary residence, in which case you may have a longer repayment period.
Some of the benefits of using a 401(k) loan to buy a house are:
- You do not have to pay any taxes or penalties on the loan amount.
- You do not have to qualify for a bank loan or pay any fees or closing costs.
- You may get a lower interest rate than other types of loans.
- You pay interest to yourself, not to a lender.
Some of the drawbacks of using a 401(k) loan to buy a house are:
- You reduce your retirement savings and miss out on potential growth and compounding.
- You have to repay the loan with after-tax dollars, which means you pay taxes twice on the same money.
- You may have to repay the loan in full within 60 days if you leave or lose your job , otherwise it will be treated as a taxable distribution.
- You may have less money available for emergencies or other financial goals.
How to Use a 401(k) Withdrawal to Buy a House
Another way to use your retirement savings to buy a house is by making a withdrawal from your 401(k). A withdrawal means taking money out of your account permanently, without paying it back. Unlike a loan, a withdrawal reduces your account balance and does not have to be repaid.
However, withdrawing money from your 401(k) before age 59Â½ usually triggers a 10% early withdrawal penalty , unless you qualify for an exception. You also have to pay income tax on the amount you withdraw , since it is no longer in the tax-deferred account. The penalty and tax apply regardless of how you use the money, whether it is for buying a house or anything else.
One exception that may allow you to avoid the penalty is if you make a hardship withdrawal