Your 401k is not only your nest-egg to retirement, but your 401k can also be used as a down payment to buy a house! Buying a home is a huge financial investment, so it’s important to understand all your options including using your 401k.
Buying a house is an exciting and emotional time, but it’s important to outline the big disadvantages that come with using your 401k to finance your home down payment.
Check your vested balance
The first thing to look into is how much of your 401k balance is actually vested. This is the amount that, hypothetically, if you left your work, you would leave with.
Every employer is different regarding how and when your contributions are vested. All employee contributions are 100% vested, however, employer match contributions may not be immediately vested depending on the employer.
The amount that is vested is the amount that you have access to and potentially withdraw and borrow from. That vested 401k amount you have access to can then be used to buy a house.
Withdrawing from your 401k
The first option is to withdraw the funds from your 401k as a Hardship Withdrawal. WIthdrawiing from your 401k is not taking a loan, so any money you take out is completely removed from your 401k retirement account.
Purchasing a home is one of the permitted reasons for making a hardship withdrawal.
|You get your down payment covered||The money you withdraw loses any potential gains over time|
|It’s easy to qualify and get the funds quickly||You pay a 10% penalty if younger than 59½|
|You pay income tax from the money you take out|
The money you receive from your withdrawal not only incurs a penalty if you are younger, but it’s treated as regular income. This means that you pay income tax on that cash, so you lose out on quite a lot of money.
Borrowing from your 401k
An alternative to withdrawing from your 401k would be to borrow from it instead. This is essentially taking a loan from yourself and paying it back over time.
|You get your down payment covered||If you leave your job, the loan balance becomes due when you file your taxes next|
|You pay yourself interest on the money you borrow||You have to pay the loan, so that increases your monthly obligations|
|The money you withdraw loses any potential gains over time|
A big advantage to doing this is that you aren’t necessarily taking money completely out of your 401k. Instead, you borrow from yourself and the money you pay back is put back into your 401k.
The biggest downsides to doing this are that if you leave your employer, you either have to pay that balance back when you file your taxes next, or risk paying hefty fees and taxes on your withdrawal.
So the question is Should you use your 401k as a down payment to your house?
The answer is It Depends. It depends entirely on your situation and financial goals. Looking at the advantages and disadvantages that come with taking out of your retirements can help you make an informed decision.