How To Tap Into Your 401k For A Mortgage Down Payment

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American retirement accounts are flush with cash, but can that money be used to buy or fix-up real estate?

There are different types of retirement accounts and among the most important are 401k plans. They held almost $7 trillion in assets as of the first quarter, according to the Investment Company Institute.

Many 401k plans – but not all – allow contributors to withdraw or borrow funds, in some cases up to $50,000.

401k Withdrawals

An account owner can withdraw 401k money under many plans. The money it contains is, after all, your money.

However, the retirement system is set up to provide long-term funding for beneficiaries and just getting a withdrawal check can set off several concerns.

“Funds in a 401(k) account,” explained Jason Co, a Certified Financial Planner with the Co Planning Group in St. Louis, “can be accessed for a variety of purposes, including making a down payment on a home, whether for personal use or for assisting someone else.

However, such a withdrawal typically triggers a 10% early withdrawal penalty, in addition to federal and state income taxes, making it a potentially costly maneuver.”

As an alternative to a withdrawal, Co said account owners should consider a 401k loan.

“When you borrow from your 401(k),” Co explained, “you do accrue interest on the loan, but you also create a structured repayment plan that avoids the income tax and the 10% early withdrawal penalty associated with direct withdrawals. This repayment scheme also provides an opportunity to replenish your retirement savings over time.”

Terrance Hutchins, a Certified Financial Planner with the Logos Financial Group in Frisco, TX, said that “you are able to utilize money from your 401K to go towards a house down payment. You would either take this out as a hardship withdrawal (if your employer allows it) or as a loan of up to $50K. 

Hutchins adds that “the hardship withdrawal would be taxable to you as income in the current year and if you are under 59.5 then you would pay the extra 10% penalty. The 401k loan you could pay that back with interest over up to a 5-year period.

However, if you separate from your employer then the payback terms may change. That would not be taxable as long as you pay the loan back per the terms.”

401K Loans for Real Estate

You’re borrowing from yourself with a 401k loan and have to pay interest. While this may seem odd, it’s actually a good idea because it means borrowed money is being returned to the retirement account and the account is earning interest. 

According to the IRS, “the maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less. For example, if a participant has an account balance of $40,000, the maximum amount that he or she can borrow from the account is $20,000.”

Sam Schwartz, a Certified Financial Planner with Anchor Pointe Wealth Management in Jackson, MO, points out that 401k loans have pros and cons. His list includes:

  • Pro: “Quick and easy access to funds, without credit checks or lengthy applications.”
  • Pro: “The interest you pay goes back to yourself, not a bank or lender.”
  • Pro: “No taxes or penalties if you repay the loan on time.”
  • Con: “You’ll need to repay the loan, usually within five years, with interest.”
  • Con: “If loan payments and regular contributions become unaffordable, your future contributions and employer match may suffer.”
  • Con: “If you leave your job, you’ll have to repay the loan in full by the due date of your federal income tax return; otherwise, it’ll be considered a withdrawal and taxed accordingly.”

Schwartz also mentions something else: “When applying for a mortgage, you’ll need to disclose the loan, which could impact your eligibility or interest rate.”

401k Loans and Mortgage Financing

Loans require repayment and this is certainly true when borrowing 401k funds. But is a 401k loan a “debt” in the usual sense of the term? After all, you’re borrowing from yourself. 

A 401k loan creates an obligation to repay a debt and this is a liability. If you don’t repay you may face taxes and penalties and such costs can impact your financial standing.

It’s financing that must be disclosed to mortgage lenders. 

401k Monthly Loan Payments

If you want to buy a $500,000 home with FHA financing you’ll need 3.5% down, a total of $17,500. In addition, buyers may face other closing costs, let’s say $10,000.

The prime rate at this writing is 8.5%. Let’s add 1.5% to give us a 10% interest level. If we borrow $27,500 over five years the monthly cost for principal and interest is $229.75. 

The best option, if reasonable, is to pay as much as possible from savings. With savings, there are no worries regarding repayment, monthly costs, interest rates, or penalties.

Also, the more you can pay from savings and other sources, the less that will be needed from a 401k and that means lower repayment costs. 

Will the $229.75 monthly cost be seen as a “debt” when the debt-to-income ratio (DTI) is calculated by a mortgage lender? If yes, does this additional monthly cost push your DTI above an acceptable level? 

For More 401K Loan Information

Different 401k plans have different rules, so what’s possible with one plan may not be possible with another. For details and specifics, before taking money from a 401k account, it will pay to speak with several specialists, including:

  • A plan representative to see what is allowed under your 401k rules. Be sure to ask about possible tax consequences, among other questions.
  • Mortgage lenders to see how they will treat a 401k loan for DTI calculations and other purposes.

A fee-only financial planner, such as a member of the National Association of Personal Financial Advisors (NAPFA), to see if there are better financing options in your situation.

Peter G. Miller

Peter G. Miller is a nationally-syndicated columnist, the author of seven books published originally by Harper & Row (including one with a co-author), and has contributed to leading online sites and major print publications. He has appeared on numerous media outlets including the Today Show, Oprah!, CNN, and NPR.

Peter has been an accredited correspondent on Capitol Hill and a member of the White House Correspondents Association. He has served with the District of Columbia National Guard and holds both BA and MS degrees from The American University in Washington, DC. View Peter on LinkedIn.

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