Should You Borrow from Your 401k to Make a Down Payment on a Home?
We’ve discussed the many different types of mortgage loan arrangements that allow you to consider buying a home, even if you don’t have the down payment for the home. These workarounds, all designed to get new home owners in with a small down payment, have both upsides and downsides.
Eventually, someone will suggest using your 401k for your down payment. And even though you have been told to never touch your 401k, you may be tempted. Should you borrow from your 401k to make a down payment on a home?
What is a 401k?
If you have a plan at your workplace, this is your best option for a well-funded retirement. While no 401k plan is perfect or even designed with your specific needs in mind, you should participate and fund the plan as soon as possible, contributing as much as possible. A friend in the financial industry gave me this rule of thumb: a five percent pre-tax contribution will have hardly any impact on your take home pay. In other words, you can save 5% of your pre-tax income and still bring the same money home. From that auspicious beginning, it is advisable to continue to tweak increases of one percent or more until you can live on what’s left. Do this even if your employer doesn’t contribute.
Can you use a 401k to buy a home?
Technically yes and theoretically no. The plan was built with several escape clauses to appease workers and to give the retirement savings plan the appearance of control, it looks like a personal account and less like those pensions of the past. It is your money. Keep in mind, those tax breaks you are getting are not free, if you plan on using the money for anything other than retirement, you pay a handsome ransom for your money. These come in the form of early withdrawal penalties and tax consequences, both of which are significant. That is the ‘yes’ part.
The ‘no’ part of the answer also came from my financial friend. He just shook his head. To him, retirement plans are sacrosanct, money put away for the day (and subsequent decades) you will not be working any longer. Each time you touch the plan, you whittle away some of the money for that distant future.
But what if you just want to borrow from your 401k for a down payment?
Turns out, the process of borrowing from “yourself” is not that complicated. Your plan administrator can help you with the process and you could have the money in a week or two. The interest rate you charge “yourself” is very reasonable. But should you?
Is there a downside to borrowing from your 401k?
There are several downsides. The contribution you would have been making to your 401k is instead channeled into your loan repayment. You could lose as much as five years or longer of these contributions at a time when the magic of compounding is at its best. Your employer match will not happen during this period either, which could cost you many additional retirement dollars. And, I saved the biggest for last: If you change or lose your job during the loan period, you have sixty days to repay yourself (the plan) in full.
The Bottom Line
One idea my financial guy suggests is to contribute the five percent minimum to your 401k and at the same time, open a Roth IRA. You can squirrel away up to $5,500 a year and the money you contributed (not the money you made on the contribution) can be withdrawn at any time. And even if the lender knows you will be using the money for a down payment, those healthy account balances will help during the application process.
How can we assist you today?
On behalf of The Jones Group @ Sunriver Realty
Nola Horton-Jones, Principal Broker/Realtor | ABR, C-RIS, e-PRO, GREEN, RSPS, CCIM Candidate
Bryce Jones, Broker/Realtor | ABR, CRS, e-PRO, GREEN, GRI, RSPS, SFR
Karen Marcy, Broker/Realtor
The Jones Group @ Sunriver Realty | 57057 Beaver Drive | Sunriver, OR 97707
Mobile: 541-420- 3725 | Mobile: 541-420- 4018 | Mobile: 503-327- 9611 | Fax: 541-593- 5123
Licensed in Oregon