Using Your 401(k) for a Mortgage Down Payment

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Updated: July 10, 2024

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If you're considering options for a mortgage down payment, your 401(k) can be a viable source. You can either borrow against your 401(k) or withdraw from it, each having distinct benefits and drawbacks.

We'll also provide insights into alternative funding sources for your down payment in case you decide a 401(k) isn't the best option. Evaluating all these options ensures your choice aligns with your long-term financial goals.

Key Takeaways

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You can use your 401(k) for a down payment by either withdrawing directly or taking out a loan against your vested balance.

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When choosing between a withdrawal and a loan from your 401(k), consider factors like financial stability, employment security and long-term retirement goals.

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Explore alternative down payment options such as using an IRA, applying for low down payment loans or seeking down payment assistance programs. Note that most assistance programs have specific credit score requirements and income limits.

Using Your 401(k) for a Home Down Payment

Can you use your 401(k) for your mortgage down payment? Many homebuyers turn to their 401(k) savings as a viable option to meet down payment requirements, allowing them to tap into this substantial asset without needing immediate cash reserves.

Your down payment significantly affects your mortgage terms, monthly payments and overall loan interest. For example, let's say you're purchasing a home priced at $350,000 and opt for a 30-year fixed-rate mortgage with a 7% APR. If you pay a 10% down payment of $35,000, your monthly payment will be $2,096. However, if you make a 15% down payment of $52,500, your monthly payment will decrease to $1,979.

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Total monthly payment$1,271
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Total monthly payment$1,271

ATTOM reported the median down payment in the U.S. in February 2024 was $50,594. Leveraging your 401(k) can make home ownership more accessible, especially in today's competitive market.

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WHAT IS A 401(K)?

A 401(k) retirement plan is a tax-advantaged account employers offer to help employees save for retirement. Unlike IRAs, which anyone can open independently, a 401(k) is available through your employer and can sometimes include a match on contributions, boosting your savings. For 2024, the IRS has set the contribution limit to $23,000, allowing significant pre-tax income to be deferred, reducing your taxable income for the year.

Withdrawing from Your 401(k) for a Mortgage Down Payment

One way to access funds for a home down payment is through a 401(k) withdrawal. You take money directly from your 401(k) retirement plan under specific conditions known as hardship withdrawals.

Fortunately, the IRS considers costs directly related to the purchase of a principal residence for the employee, excluding mortgage payments, as an immediate and heavy financial need that may qualify you. To make a 401(k) withdrawal, submit a request through your plan administrator, who determines your eligibility based on IRS regulations.

Pros and Cons of a 401(k) Withdrawal

Explore the pros and cons of using a 401(k) withdrawal if you’re considering this option.

Pros
Cons

Immediate funds for down payment: Access to necessary funds without the need to secure a loan or other financing.

Incurs income tax and potential shift to higher tax bracket: Withdrawing increases taxable income for the year, possibly resulting in a higher tax rate.

No requirement to repay: Unlike a loan, the withdrawn amount does not need to be repaid to the 401(k) account.

Possible 10% early withdrawal penalty: If not qualified as a hardship under IRS rules, withdrawals might incur a 10% penalty if you’re under 59 ½.

Permanent reduction in retirement savings: Money withdrawn cannot be replaced, reducing the total amount available at retirement.

Loss of future tax-free earnings: Withdrawn funds miss out on potential growth and tax-free earnings within the 401(k).

Securing a 401(k) Loan for a Mortgage Down Payment

A 401(k) loan offers another way to leverage your retirement funds for a home down payment. Unlike other loans, it taps into your vested retirement savings without incurring taxes, provided repayment terms are met. Here’s what you need to know about the process and benefits:

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    Borrowing Limit

    You can borrow up to 50% of your vested account balance, not exceeding $50,000. However, the borrowing cap may be reduced if you had another loan from any employer-related plan within the last year.

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    Tax Implications

    A 401(k) loan is not taxable if it meets the plan's criteria and repayment terms.

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    Repayment Terms

    The loan must be repaid within five years, with repayments made in substantially level amounts at least quarterly. However, the repayment period may extend beyond this term if you use the loan to buy your primary residence.

Pros and Cons of a 401(k) Loan

Instead of just focusing on the benefits of a 401(k) loan for your down payment, it's best to weigh both sides. Our table outlines the pros and cons, providing a clear comparison to help you decide if it fits your financial goals and retirement strategy.

Pros
Cons

Borrow a significant amount: Access substantial funds (half of your account’s value, up to $50,000) without external credit checks.

Must generally repay within five years: A relatively short repayment period could strain your finances and require you to adjust your budget.

Interest paid goes back into your account: Unlike traditional loans, the interest you pay enhances your own retirement fund, not a bank’s profits.

Must disclose loan when applying for a mortgage: Lenders do not count a loan from a 401(k) against the debt-to-income ratio. While you must disclose this loan to your lender and provide proof of its source, the monthly payment is not factored into your debt obligations because you are repaying yourself.

Extended repayment flexibility: Under the Tax Cuts and Jobs Act, if you leave your job, the repayment deadline extends to your federal tax return due date, offering more time than the previous 60-to-90-day window.

Must repay quickly if you leave your job: Failure to repay by the tax return due date turns the loan into a withdrawal, incurring taxes and possible penalties.

May be unable to contribute to 401(k) until loan is repaid: This could slow your retirement savings growth.

Missed potential investment growth: The borrowed money could have earned significant investment returns, which are lost while it is loaned out.

Choosing Between Borrowing and Withdrawing from Your 401(k) for a Down Payment

Using your 401(k) for a mortgage down payment offers immediate financial relief but has long-term consequences. Consider these aspects carefully so you can determine the best approach for your financial situation and future needs:

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    Financial Stability

    Evaluate your current financial health. Loans require repayment, which adds a monthly financial burden, while withdrawals reduce your retirement nest egg.

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    Employment Security

    Assess your job stability. If you lose your job, a 401(k) loan typically must be repaid promptly, or it could be treated as a taxable distribution.

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    Retirement Goals

    Consider how close you are to retirement and your retirement savings goals. Withdrawing funds can impact the growth potential of your retirement portfolio more significantly than borrowing.

Let’s see how these play out in real-life scenarios.

Emily’s Down Payment Strategy

Emily, a 36-year-old software developer, and her husband are eager to buy their first home. They have some savings but need more to achieve a 20% down payment to avoid private mortgage insurance. Given Emily’s stable career and their combined ability to replenish savings quickly, she opts for a hardship withdrawal from her 401(k). This allows the couple to meet their down payment goal, leveraging Emily’s financial stability to manage the extra tax implications efficiently.

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IS IT BETTER TO WITHDRAW OR TAKE A LOAN?

The immediate access to funds helps secure a lower mortgage payment and saves on private mortgage insurance, proving financially beneficial despite the potential long-term impact on her retirement savings. Growth in the value of their home can help offset the withdrawal over time. Their strong financial footing and high savings rate enable them to offset the tax drawbacks of a 401(k) withdrawal, strategically positioning them for both immediate homeownership and future financial security.

How Tom Eased His Home Purchase

Tom, a 42-year-old school teacher, is planning to move closer to his new job at a well-funded suburban school district. With a stable job and a moderate amount of savings, Tom needs additional funds for a down payment to avoid a high-interest mortgage. After reviewing his options, Tom decides to take a 401(k) loan. It allows him immediate access to funds with the benefit of paying interest back into his own account, a manageable strategy given his job security.

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IS IT BETTER TO WITHDRAW OR TAKE A LOAN?

Tom's decision to opt for a 401(k) loan is strategically sound because it provides the necessary funds for a substantial down payment, reducing his monthly mortgage payments and interest costs. Tom seamlessly integrates the repayment into his budget by repaying the loan through payroll deductions. Tom expects to keep his job for a while, which ensures he can handle the loan repayment terms without jeopardizing his financial future.

Alternatives to Using Your 401(k) for a Down Payment

While using your 401(k) for a down payment can be beneficial, it’s not always an ideal strategy — mainly due to potential long-term impacts on retirement savings. Exploring other down payment options ensures you make the best financial decision without compromising your future security.

Here’s a table providing a concise overview of alternative down payment options, detailing how each works and who should consider them:

Options
How It Works
Who Should Consider It

Save more before buying

Postpone your purchase to save more, increasing your down payment and reducing loan needs.

Those with flexible timelines who can benefit from lower loan limits.

Utilize an IRA

Withdraw funds from an IRA. Some penalties may be avoided for first-time homebuyers.

First-time buyers needing immediate funds with fewer penalties.

Explore low down payment loans

Consider loans that require smaller down payments, such as FHA or VA loans. VA loans are available exclusively to veterans or active duty personnel, while FHA loans are open to broader eligibility.

Buyers with limited savings but stable income.

Seek down payment assistance

Apply for grants and loans from government and non-profit organizations.

First-time buyers and households with lower income.

Accept gifts from relatives

Use monetary gifts from family to cover part or all of the down payment.

Those with generous families willing to financially assist.

FAQ About Using Your 401(k) for Your Down Payment

We answered common inquiries about using your 401(k) for a down payment, providing insights to help you understand the implications and benefits of this financial strategy. At the end of the day, you should use your 401(k) as a last resort for funding. Your 401(k) is meant to help with retirement, so it’s best to let the money mature and grow over time.

Should I use my 401(k) for my mortgage down payment?
At what age can I withdraw from 401k without penalty?
Can I withdraw from 401k early?
Can I borrow against my 401k?
Is there a 401(k) exemption for a first-time homebuyer?

About Zachary Romeo


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Zachary Romeo is the Head of Loans and Banking at MoneyGeek, with over 10 years of experience and forthcoming certification as a Commercial Banking and Credit Analyst (CBCA). Previously, he led production teams for some of the largest online informational resources in higher education.

Romeo has a bachelor's degree in biological engineering from Cornell University. He geeks out on minimizing personal debt through people-first content.


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