Can I Use My 401(k) to Buy a House?

Yes, you can use your 401(k) to purchase a house, but it’s generally discouraged. A 401(k) plan is a retirement savings account that allows employees to save for retirement with significant tax advantages.

Recall that the primary purpose of a 401(k) is to provide a tax-advantaged way to save for retirement. Funds in pre-tax, traditional 401(k)s are taxed upon withdrawal, while funds in after-tax Roth 401(k)s are taxed at the time of contribution (but come with tax-free withdrawals in retirement!).

At the same time, homeownership is desirable for many individuals in their 20s and 30s, and having enough money to make a down payment can be challenging. Using your 401(k) to help with a down payment can be tempting and is often done, but it comes with significant risks.

In this article, we’ll explore the pros, cons, and steps for using a 401(k) to purchase a new home, as well as the alternative options you might consider.

How to Use Your 401(k) for a Home Purchase

Two main ways to use your 401(k) to buy a house are through a 401k loan or through an early withdrawal.

Below, we’ll briefly outline each option’s eligibility requirements, rules, and restrictions.

401(k) Loan

A 401(k) loan involves borrowing money from your retirement plan. You can borrow up to 50% of your vested account balance, or $50,000 — whichever is less — to fund your down payment.

One exception: if your vested account balance is less than $10,000, you can borrow up to $10,000 to fund your down payment.

You’ll have to make repayments to your 401(k) plan to “pay yourself back” for the loan. Interest rates on those repayments are usually competitive, usually slightly above the current prime rate.

Normally, you have to pay 401(k) loans back within five years and make payments at least quarterly. For the purchase of your primary residence, however, you won’t need to pay the loan back within the typical five-year repayment period. Just make sure to use your loan proceeds for a home purchase!

Some pros and cons of using a 401(k) loan to buy a house:

• Pros: You’ll avoid the normal 10% early withdrawal penalty and access potentially lower interest rates than if you were to use another funding method.
• Cons: Reduced tax-deferred retirement savings, loan repayments, potential tax implications if the loan isn’t repaid on time, and a potential pause on employer contributions (if you stop making active contributions on top of your loan repayments).

401(k) Withdrawal

A 401(k) withdrawal — not a hardship withdrawal — allows you to take money from your 401(k) plan due to purchase a home.

With a hardship withdrawal, you must have an immediate and heavy financial need, according to the IRS. The IRS does not consider a 401(k) withdrawal to fund a down payment to be a hardship withdrawal, so you won’t receive any sort of penalty exemption if you go to make a withdrawal for a home purchase.

As a result, a 10% early distribution penalty will apply if you choose to take your withdrawal for the purposes of a down payment — even if it’s your first home and/or your primary residence.

Traditional (or pre-tax) 401(k) withdrawals are also subject to ordinary income tax.

Some pros and cons of using a hardship withdrawal to buy a house:

• Pros: Access to funds for a down payment or closing costs for first-time homebuyers.
• Cons: 10% early withdrawal penalty, an increase in taxable income for the year of withdrawal, and reduced retirement savings.

If you’re considering using 401(k) funds, always consult with your plan administrator, plan provider, financial advisor, and/or tax advisor to get detailed guidance about how to best use your retirement account.

Pros and Cons of Using 401(k) to Buy a House

When considering using your 401(k) retirement funds to make a down payment, it’s essential to analyze the potential upsides and downsides before jumping to any conclusions.

Pros

1. Access to a sizable down payment: Using 401(k) funds can help you gather enough money for a down payment. It can also mean avoiding down payment assistance programs.
2. Potential to avoid private mortgage insurance (PMI): A larger down payment may help you avoid PMI, and it can also help you lower your monthly mortgage payment. It also won’t negatively affect your debt-to-income ratio in the eyes of most credit bureaus.
3. Utilizing retirement savings as an investment in real estate: Investing in a home can potentially provide long-term financial benefits if the real estate market goes up over the duration of your home ownership.

Cons

1. Impact on retirement savings and long-term goals: Using 401(k) funds for a home purchase can reduce the amount available for retirement by depleting your funds and reducing the compound growth your account may otherwise experience.
2. Possible tax implications and penalties: Early withdrawals may be subject to taxes and penalties. Typically, the early withdrawal penalty is 10%. Remember that using a 401(k) withdrawal for a down payment will not be categorized as a hardship withdrawal.
3. Limited availability of funds for future investments: Tapping into your 401(k) may limit the funds available for other investments in the future.

Should You Use Your 401(k) to Buy a House?

Before using your 401(k) savings for a home purchase, consider the potential impact on your retirement savings, personal financial goals, and the availability of alternative financing options.

Weigh the pros and cons, and consider factors such as current home prices, new contributions to your 401(k), and your overall financial stability.

In the next section, we’ll explore other home loan options you should consider before withdrawing funds from your 401(k).

Alternatives to Using Your 401(k) for a Home Purchase

IRA

Individuals can use funds from a Roth IRA or traditional IRA for a home purchase down payment, provided they meet eligibility requirements. There may be implications for federal taxes depending on the type of IRA and the withdrawal amount.

Individual retirement accounts have provisions for first-time homebuyers, allowing them to withdraw $10,000 for a first-time home purchase without having to pay the 10% early withdrawal penalty.

Mortgage Loan

Conventional mortgage loans require a down payment, credit score check, and satisfactory debt-to-income ratio — all of which will need to meet the lender’s requirements. Interest rates and mortgage payment terms vary based on the borrower’s qualifications.

Mortgage rates also change over time, so consider how the current mortgage rates compare to the 401(k) repayment rate (usually a bit higher than the current prime rate).

Down Payment Loan

Down payment loans (or personal loans) have eligibility requirements, varying interest rates, and bespoke repayment terms. These loans can help cover a down payment for a home purchase.

There are also down payment assistance programs for those who meet eligibility requirements.

Be sure to exercise caution if you’re considering a down payment loan, since at the end of the day, it is just another form of debt.

FHA Loan

Federal Housing Administration (FHA) loans have more lenient eligibility requirements, lower down payment options, and benefits for first-time homebuyers seeking a primary residence.

Typically, those seeking FHA loans tend to have credit scores on the lower end of the score range.

VA Loan

Department of Veterans Affairs (VA) loans are available for eligible service members and veterans. Benefits include lower interest rates, and often no down payment is required.

FAQs

Can I use 401(k) to buy a house without penalty?

Using a 401(k) loan to buy a house will not incur an early withdrawal penalty, but if you choose to make a taxable withdrawal of funds, you might be facing both taxes and penalties.

Speak to a financial advisor to fully understand the implications for your finances.

How much of my 401(k) can I withdraw to buy a house?

You can withdraw any amount you want to buy a house, but remember that a withdrawal will lead to both ordinary income tax and early withdrawal penalties (if you’re under 59.5).

With a 401(k) loan, you can borrow up to half of your vested balance or $50,000, whichever is less. You can borrow up to $10,000 if your vested balance is less than $10,000.

Be careful when discussing loans and withdrawals, as the two are different.

Can I use my 401(k) to buy a second house?

Yes, although the same tax and penalty provisions around withdrawals and loans will apply.

401(k)s do not provide a penalty waiver for first-time homebuyers in the same way that IRAs do.

Need Help Considering Your Options?

Using a 401(k) to buy a house has pros and cons. While it seems like easily accessible money, you might be faced with financial penalties and tax implications.

It’s essential to consider alternative financing options and the potential impact on your retirement savings before making any significant financial decision. As such, it’s smart to speak to a financial advisor for help in becoming a homeowner.

If you’re considering a 401(k) rollover and don’t want to do the heavy lifting yourself, consider working with Capitalize. We manage the process and help you set up optimal retirement savings.

Learn more about how we can help you get started.