Owning a home is still the American dream, but coming up with the funds for a down payment can sometimes be challenging. If you are struggling to come up with a down payment to purchase your first home, you may have given some thought to borrowing from your 401(k) retirement plan. There are a few things to consider before making this decision when you buy a house.
Can You Borrow From Your 401(k)?
Can you borrow from your 401(k) to make a down payment on a house? Will you have to pay a penalty/fee for doing so, and what rules should you be aware of? And most importantly, is this a wise course of action, or are there other sources of down-payment cash that should be explored first?
Borrowing from a 401(k) is often a simpler process than taking out a traditional loan. You don't have to worry about stringent pre-qualification requirements and the paperwork is relatively simple and straightforward. Your interest rate is typically lower with a 401(k) than with a traditional loan, and you don't have to worry about keeping up with your payments as they are automatically deducted from your paycheck.
If you borrow from your 401(k) to use to buy a house, the money is not subject to income tax or a withdrawal penalty. Your monthly payments on the 401(k) loan are often low and at a lower interest rate than you may be able to get on a traditional bank loan. The amount of your 401(k) loan monthly payment will of course vary depending on how large your loan is and how long your repayment terms are.
Typically, you are allowed to borrow up to 50% of your 401(k) account balance. Check with your company's employee benefits director for all the details on 401(k) loans. Most companies allow you to take up to five years to pay back a 401(k) loan.
Consider Your Credit Score Before You Buy a House
Another thing to consider is your credit score. Borrowing from your 401(k) will not affect your credit score. If you are concerned about the potential loss of interest income from your retirement account, perhaps it is a good idea to consider other options for financing a home down payment. For Veterans, a VA Loan can often be obtained at a low-interest rate and could be an option to consider as an alternative to borrowing from a 401(k) plan.
A 401(k) loan to finance a home down payment may potentially affect your ability to be approved for a mortgage as the loan officer will add the amount of your 401(k) loan to your debt ratio.
Do Your Research
When deciding if you should borrow from your 401(k) savings to purchase a home, remember that you will be missing out on the investment savings the money would be making to go toward your retirement savings. Will the loan jeopardize your quality of living during retirement? After all, retirements savings are intended for just that--making sure you can live comfortably during your senior years. Depending on how close to retirement you are, it could make sense to check out alternatives loan options. Also, if you are thinking of changing jobs soon, you should check on the 401(k) loan repayment requirements. Some plans require you to repay the loan in full when you leave your job.
Buying a home is one of the biggest financial investments you will ever make. If you have considered the pros and cons and decided to pursue a 401(k) loan to purchase your home, it is still a good idea to consult with a financial advisor before you make the final purchase. All things considered, there are some good reasons why using a loan from your 401(k) retirement loan makes sense. Only you can decide if it is the right option for your family.