Borrowing Against 401(k) to Purchase a Home: Financial “Do”, or “Don’t”?
Many first time homebuyers are ready to take on the expense and responsibility of homeownership but lack the significant down payment that is generally required as part of a mortgage loan, or that is required in order to avoid the additional purchase of private mortgage insurance (or, PMI). While many prospective homeowners may not have a lot of cash in liquid savings, they do have alternate investment resources which inevitably leads down the train of thought in which the wonder, "what about tapping into our 401(k) or other retirement savings to use as a down payment and closing costs?" If this situation sounds all too familiar, and you are many years from your expected retirement age, ask yourself this question: Does it make sense financially to either
Can you either withdraw or borrow money from a 401(k) account before you reach retirement age?
Yes; there are no laws or rules that prevent individuals from withdrawing money from their retirement accounts before they reach retirement age. That said, there may be some tax penalties associated with early withdrawals from retirement accounts that you’ll want to take into consideration before taking any money out of your retirement funds. 401(k) generally allow for the owner of the account to borrow money from the retirement account for the purchase of a home. These withdrawals are not subject to a tax penalty, but they are in the form of a loan, which must be repaid to your retirement account.
Things to consider before borrowing money from your 401(k)
Borrowing money from your 401(k) to purchase a home is often a pretty quick and pretty easy process; but does it make sense for you to tap into your retirement savings to purchase a home? In order to determine what makes the best financial sense for you and your family, you’ll want to weigh the pros and cons to borrowing money from a 401(k) to fund your home purchase.
- You will have to pay back the money you borrow. When you borrow from a 401(k) to purchase a home, you generally will have several years to repay the amount borrowed. You’ll want to make sure that you can swing this extra monthly payment in addition to your new mortgage. Additionally, if you leave your employer (the company sponsoring your 401(k)) before you repay your loan, you may have to repay the entire balance of the loan within just 60 days or be subject to a tax penalty. If you plan on changing careers and employers in the near future, this is definitely something you’ll want to keep in mind.
- You may impact your future retirement savings. If you are able to quickly repay the amount borrowed from your 401(k), you may not impact your savings significantly over the long term. But, any money you withdraw from your 401(k) won’t be growing towards your retirement savings.
Finally, if you are borrowing money from your 401(k) in order to avoid paying for private mortgage insurance or PMI, you’ll want to calculate what your monthly PMI payment would be and whether it makes more sense to just pay that until you reach the needed equity in your home to request PMI removal.
Have you ever borrowed from a retirement account to help fund a home purchase? What factors would you suggest to others considering borrowing from a 401(k) to buy their first home? Tell us in the comments below!