You usually hear that it’s imperative to save for retirement as early as you can. That advice will serve you well as you get closer to retirement age and all of that planning starts to become reality.
Much of the expert advice and guidance you receive from your trusted connections will also generally tell you to avoid withdrawing or taking out loans from any of your retirement plans, such as a 401(k).
But what about when you’re trying to buy a home and take out a mortgage? Is it a good idea to leverage your 401(k) to help you cover your down payment or closing costs? Will it end up costing you more in the long run? We will break down what you should know about using your 401(k) to get a mortgage here.
Should I Use My 401(k) For My Down Payment?
The first question for many buyers thinking about using their 401(k) to help cover their down payments or closing costs is, “Is this really a good idea?” The answer depends on your personal financial situation.
Your 401(k) is meant to be your retirement plan, so withdrawing funds from it early can disrupt your retirement planning and come at a cost.
You have to consider your overall financial situation, though. If you’re able to save on your housing costs versus renting, and you’re buying in an area with healthy home value appreciation, that might justify the short-term costs you incur to take funds from your 401(k).
If you do end up taking from your 401(k), you’ll want to develop a realistic plan to ensure you’re still on track for your retirement goals.
Taking A 401(k) Withdrawal
If you withdraw funds from your 401(k) before retirement age to help make your homeownership goals a reality, you’ll get charged a 10% early withdrawal penalty. There are no penalty fees if you’re over the age of 59 1/2 or for some other exceptions.
Additionally, because contributions to your 401(k) account are not taxed as they’re going in, you’ll also be responsible for income tax on your withdrawal amount.
Between these two costs associated with early 401(k) withdrawals, it’s usually not cost-effective to take money out to cover your down payment or closing costs.
Taking Out a Loan From Your 401(k)
A better option for utilizing your 401(k) to help you purchase a house is to take out a loan from your account. Loans from your 401(k) don’t incur early withdrawal penalties, and you don’t have to pay income tax on the loan amount.
You do have to pay your account back with interest, however. And there are limits on how much time you have to pay back the loan, which vary based on your account. The typical maximum loan term is five years, but you should refer to your specific account information for more details and exceptions.
Since a 401(k) loan doesn’t incur early withdrawal penalties or have income tax implications, it’s usually the preferred option for buyers interested in using their retirement to supplement their other savings.
Alternatives to Pulling From Your 401(k)
Before you consider pulling from your 401(k), you should look at other options that have less costs associated with them and don’t disrupt your retirement savings plan.
Down Payment Assistance Programs
There are lots of special mortgage programs out there, especially for first-time buyers, that allow for low-to-no down payment, or offer grants to help cover your down payment and closing costs.
Withdrawing From Your IRA
In contrast to 401(k) withdrawals, account holders are able to take early distributions from their IRAs without penalty for qualified financial hardships or under special provisions for first-time homebuyers.
Withdrawing From Your Roth 401(k)
If you have a Roth 401(k), you can withdraw contributions that you made tax-free and penalty-free. Fees would only be incurred if you tap into your earnings by taking out more than you contributed.
There are many options available to help you come up with the down payment and cover the closing costs of your new home purchase. And you don’t have to figure out what the best financial option is for you on your own.
Get in touch with one of our lending experts, who will learn about your financial situation and go over various mortgage options that are suited to your needs, all in a free consultation.
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The included content is intended for informational purposes only and should not be relied upon as professional advice. Additional terms and conditions apply. Not all applicants will qualify. Consult with a finance professional for tax advice or a mortgage professional to address your mortgage questions or concerns. This is an advertisement. Prepared 7/28/2022.