As a First-Time Homebuyer - Can I Use My 401(k) For a Down Payment?
- Apr. 29, 2022
- Rob Spires
- Real Estate Tips
It’s a fact: The housing market is hot and competition for homes is becoming increasingly intense. While entering the market is nerve-racking for most buyers, it can be especially stressful for first-time homebuyers who are trying to come up with the necessary funds to make a down payment. This has led some first time home buyers to look toward non-traditional sources – such as their 401(k) – to come up with the money they need.
Here, we’ll examine how to, and if you should, make a 401(k) withdrawal to use as a source for a down payment as a first-time homebuyer.
Can a 401(k) help you make a down payment?
The short answer is yes. The longer answer is yes, but…
First things first – your 401(k) is your money to use at your discretion. While it doesn’t function the same way as a standard deposit account, you still have the right to access it if you choose to do so. If you’re like many, your 401(k) is your largest financial account, and it can certainly be tempting to use these funds as the source of your down payment. However, there are some distinct drawbacks to this strategy, including penalties, taxes, and potential repayment requirements.
By design, your 401(k) is a retirement account meant to last you well into your golden years, so you shouldn’t just freely dip into it here and there. Until you turn 59 ½ (or 55 if you’re no longer working), there is a 10% early withdrawal penalty on any money you take out. Additionally, you will have to pay income tax on the amount withdrawn.
Typically, those who decide to use their 401(k) as a down payment source are first-time homebuyers who likely don’t have the savings or assets to make a down payment otherwise.
If you’ve weighed the pros and cons and believe using the funds in your 401(k) is the best choice for you, you have two options for accessing your money.
- 401(k) Loan: In this scenario, you are simply borrowing from yourself. All funds you withdraw will have to be repaid with interest (typically the prime rate, plus 1-2 interest points).
- 401(k) Withdrawal: By withdrawing money, you avoid any repayment requirements. However, you will incur a 10% penalty and be required to pay income tax on the amount withdrawn.
Let’s take a deeper look into each of these options.
Because of the penalties and taxes assessed to 401(k) withdrawals, a 401(k) loan is likely to be the lower-cost option.
Generally, these loans aren’t reported to credit bureaus, so they’re unlikely to affect the debt-to-income ratios that are evaluated to determine mortgage qualifications. However, depending on the loan type you’re applying for, this may not necessarily be the case. As always, it’s best to work alongside a qualified Loan Officer when securing funding for a home purchase.
There are also some downsides and potential risks associated with 401(k) loans. First, you won’t be able to make any new contributions while you’re paying off your loan, and your employer won’t be contributing either. Compound that with the potential interest you’re missing out on, and it could make a pretty big impact on your retirement savings.
Generally, 401(k) loans are repaid over five years, though when used for home loans the repayment period can sometimes be longer. However, it’s important to note that if you leave your current job, you will be required to repay the loan in its entirety by the next year’s tax filing date. Any money not repaid by the due date will be considered a withdrawal and is subject to all penalties and taxes that entails.
Unlike a 401(k) loan, 401(k) withdrawals don’t come with any repayment requirements. However, they do come with the penalties and taxes mentioned above. Also, you lose the security of knowing that this money will be paid back to your account for retirement.
Before you decide to take this approach, we strongly recommend that you speak with a Loan Officer or other financial professional for complete details and information about other options that may be available.
Can you use your 401k to buy a house without penalty in 2022?
There are limits to how much you can withdraw from your 401(k), so likely you won’t be able to purchase your house outright. Typically, this limit is 50% of your 401(k)’s vested account balance or $50,000, whichever is less. And of course, if you choose to make a withdrawal, all penalties and taxes would apply.
Because of this limit, if you do decide to dip into your 401(k), it is best used as a down payment source.
Are there other options?
Certainly! We encourage you to talk to a New American Funding Loan Officer to learn about other Conventional loans and government-sponsored programs (including low- and no-down payment options) that could help you get into your new home.
Additionally, we offer a mortgage calculator that can help you begin thinking about your budget.
If you’re in the market for a new home or simply want to discuss your financing options a first-time homebuyer, we’d love to hear from you today!