Should You Borrow From Your 401(k) to Buy a House?
If you’re purchasing a home then you’re going to need a down payment. Many home buyers are not aware that they are able to withdraw from their 401k to use for the down payment. Obviously there are some drawbacks to doing so. Use a house payment calculator to estimate your monthly mortgage payment. You can input a different home price, down payment, loan term and interest rate to see how your monthly payment changes. In this article we’re going to take a deeper look into the pros and cons of using funds from your 401k to buy a house.
Pro – Borrowing from Yourself
You’re the owner of your 401K, which means that when you borrow against it, you pay interest to yourself. While it’s a pro to make money off your loan, instead of paying it to a bank, it’s unlikely to be the same as how much you’d make if the funds had been invested in the market.
Interest rates on 401K loans are typically tied to the Prime and can be quite low. The interest that you’re paying yourself is tax-deferred, just like any gains in a 401K portfolio. You won’t pay taxes on it until the funds are distributed after retirement.
Con – Borrowing Limits
When you borrow money from your 401K, you can only borrow up to 50% of the total amount in your account. And you can only borrow against vested funds. There is a $50,000 legal limit on your total borrowing amount and a $1,000 minimum. The average down payment in your area might not be 20% of the selling price, however. And if you’re just $5,000 shy of a down payment that would help you avoid paying Private Mortgage Insurance, you can borrow only that amount from your 401K. The repayment term can also be a negative.
Pro – Approval is Easy
Since you’re borrowing from yourself, you don’t need to go through a rigorous loan approval process as you would if a lender provided financing. Even bad credit borrowers can get 401(k) loans and it’s usually just a matter of filling out some paperwork with your 401(k) administrator,
as long as your plan allows loans.
Con – You Could Get Penalized if You Don’t Pay the Loan Back
If you fail to repay your 401(k) loan on schedule, your loan will be treated as a withdrawal. The IRS requires payments to be made at least quarterly and payments must be “substantially equal” and include both principal and interest. If you don’t pay back your loan as required and it is treated as a withdrawal, you’ll be taxed on the withdrawn funds and face a 10% penalty for early withdrawals if you aren’t 59 1/2.
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