Borrowing From Your 401
Because that money is meant for retirement, withdrawals are discouraged before you reach age 59 ½. There is a 10% penalty on the loan amount and youll have to pay federal income tax on the amount withdrawn, if you choose to withdraw money before that age.
Exceptions to this include: youre using the money to pay medical expenses, youve become disabled, if youre required to perform military duty and/or youre required to follow a court order. The other exception is if you’re 55 and an employee who is laid off, fired, or who quits a job between the ages of 55 and 59 ½, you may access the money in your 401 plan without penalty, according to the IRS.
Some 401 plans allow participants to borrow from their retirement savings. If you’ve built up some money in a retirement account, that may be a source of funds for consolidating your debt. It can be easier to borrow from your 401 than getting approved for a loan from an outside lender. Plans often require employees to repay through payroll deductions so your monthly take-home pay will be reduced by the loan payment.
401 plans typically require that loans be repaid within five years meaning your monthly payments will be higher than loans with a longer term. Some plans do not allow participants to contribute to the plan while they have a loan outstanding. You’ll also miss out on any matching contributions from your employer during that time.
Comparing Loan Vs Cashing Out
While cashing out may result in a higher mortgage and lower interest payments, there is one financial drawback with this option: You may not be able to replace the money in your 401k. Each year, there is an annual maximum on 401k contributions. Once you take this money out, you cannot add it back in if your contributions will be over the annual maximum. Therefore, you could be permanently reducing the funds in your 401k with this option, which will significantly reduce the money you can save and earn for retirement.
References
The Millionacres Bottom Line
To sum it up, you can’t purchase real estate directly with funds in an employer-sponsored 401k plan if you’re still an active participant in the plan. However, if you have money in a former employer’s 401k plan or are self-employed, there are some good options that can allow you to put your retirement savings to work in investment properties and other types of real estate investments.
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When Borrowing From Your 401k Is A Bad Idea
Borrowing from your retirement plan for any reason is a risky proposition. There are several pitfalls to borrowing from your 401k or IRA account to buy a house.
If your debt-to-income ratio is high and youre already cutting your monthly budget pretty thin by getting a mortgage, then having a separate loan payment may make using your 401k to buy a house a terrible idea.
And even if you have plenty of money left over after paying your bills, tapping into your 401k should still be a last resort.
Your Retirement could be Harmed in the Long-Term
When borrowing from your 401k, you may not be able to contribute additional funds to your account while repaying the loan.
If your employer offers any retirement contribution matches, you will not be able to take full advantage of it.
When looking at your retirement savings in the long-term, the total amount will be less than it could because you cannot contribute for years.
Tax Penalties
When you withdraw funds from your retirement plan, you are subject to a 10% income tax penalty. The fund that money is in may also have an early-withdrawal fee.
The tax penalty is waived if you are getting a 401k loan and are repaying the amount borrowed.
However, if you leave your current employer for any reason, you may have to repay any loans within 60 days. If youre unable to repay within the window of time, you could face a 10% tax penalty.
How Much Can You Borrow From 401 To Buy A House
Generally, you can borrow up to half the value of your current balance or $50, 000 from your 401 to buy a house. The maximum amount that you can loan is the lower amount between the two.
For example, if you have $90, 000 as your current balance and you divide it by two you would have $45, 000. This means that you can borrow up to $45, 000 from your 401 plan, since it is the lesser amount. However, if you have $110, 000 as your current balance and you divide it by two you would have $55, 000. This means that you can borrow up to $50, 000 from your 401 plan, since $55, 000 would exceed the maximum loan amount which is $50, 000.
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Can I Use My 401k To Buy A House 4 Possible Options
February 8, 2015 by Justin
At first glance when people ask themselves Can I use my 401k to buy a house, it doesnt seem like such a terrible option. Chances are youre probably young and sitting on several thousand dollars that you dont plan to use until decades from now. Why not use the money in the present when you need it today?
However youve got to remember that because your 401k was intended to be used for retirement, it wont be as easy as withdrawing the funds you need. Youll need to know a few of the rules and how to avoid paying unnecessary taxes and penalties.
Here are a few of the options youll have to choose from.
Drawbacks To Using Your 401 To Buy A House
Even if it’s doable, tapping your retirement account for a house is problematic, no matter how you proceed. You diminish your retirement savingsnot only in terms of the immediate drop in the balance but in its future potential for growth.
For example, if you have $20,000 in your account and take out $10,000 for a home, that remaining $10,000 could potentially grow to $54,000 in 25 years with a 7% annualized return. But if you leave $20,000 in your 401 instead of using it for a home purchase, that $20,000 could grow to $108,000 in 25 years, earning the same 7% return.
Also Check: How To Roll 401k Into New Job
Using Your 401k For A Down Payment
Theres no specific penalty exemption for home purchases when you pull money out of a 401k, so any money you take out will be classified as a hardship exemption. Youll be assessed a penalty of 10% on the amount withdrawn and youll have to pay income tax on it as well.
If possible, roll over the amount you want to withdraw to an IRA, so you can avoid paying the penalty. However, you cant roll over a 401k thats with an employer for whom you are still working. If you have an old 401k from a former employer, roll that. Since a rollover can take time to process, fill out the necessary paperwork as soon as possible.
How The Coronavirus Changed 401 Loans
The CARES Act that was signed into law last month doubles the amount you can borrow from your 401 or 403 to $100,000, or up to 100% of your account, whichever is lower.
Borrowers also can defer loan payments for a year. So you essentially have six years to pay back your loan. The additional year for paying back the loan also applies to existing loans, but check with your plan administrator before you delay any repayments.
Note that interest will still accrue during this time. But you wont owe income tax out the amount you borrowed as long as you pay it back within the loan timeframe.
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Withdrawing From A 401
The first and least advantageous way is to simply withdraw the money outright. This comes under the rules for hardship withdrawals, which were recently made a little easier, allowing account holders to withdraw not just their own contributions, but those from their employers. Home-buying expenses for a “principal residence” is one of the permitted reasons for taking a hardship withdrawal from a 401.
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You owe income tax on the withdrawal.
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The withdrawal could move you to a higher tax bracket.
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If you are younger than 59½, you also owe a 10% penalty on the money you withdraw.
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You can never repay your account and lose years of tax-free earnings on the money you withdraw.
If you withdraw money, however, you owe the full income tax on these funds, as if it were any other type of regular income that year. This can be particularly unappealing if you are close to a higher tax bracket, as the withdrawal is simply added on top of the regular income. There is a 10% penalty tax, also known as an early withdrawal penalty, on top of that if you are under 59½ years of age.
401 plans do not have a first-time homebuyer exception for early withdrawals, but IRAs do.
Cons Of Borrowing From A 401k
While pulling from your 401k may seem like a great option, there are some drawbacks and risks involved. Top cons include:
- Paying interest on the amount withdrawn
- The full loan amount is due if you leave your employer before the loan is repaid
- In the case of a withdrawal, youâre pulling from your retirement fund, which can impact your financial health in the future
Recommended Reading: What Happens To My 401k When I Leave My Job
How Do You Take A Withdrawal Or Loan From Your Fidelity 401
If you’ve explored all the alternatives and decided that taking money from your retirement savings is the best option, you’ll need to submit a request for a 401 loan or withdrawal. If your retirement plan is with Fidelity, log in to NetBenefits®Log In Required to review your balances, available loan amounts, and withdrawal options. We can help guide you through the process online.
Failing To Repay A 401 Loan
If you fail to make scheduled payments for a 401 loan, the entire remaining balance of the loan will be treated by the IRS as a distribution. Also, if you leave your job before repaying the loan, you have a limited amount of time to repay it or it will be treated as a distribution. A 401 loan thats treated as a distribution is classified as taxable income by the IRS. In addition, workers below age 59 1/2 in this situation are subject to a 10 percent IRS penalty for early withdrawal from their retirement account. Retired workers with reduced incomes should carefully consider 401 loan repayment after leaving the job to avoid the tax penalties for defaulting.
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Next Steps To Consider
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
Getting A Second Mortgage
A second mortgage is a second loan that you take on your home. You can borrow up to 80% of the appraised value of your home, minus the balance on your first mortgage.
The loan is secured against your home equity. While you pay off your second mortgage, you also need continue to pay off your first mortgage.
If you cant make your payments and your loan goes into default, you may lose your home. If thats the case, your home will be sold to pay off both your first and second mortgages. Your first mortgage lender would be paid first.
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Getting Cash Out With A Mortgage Refinance
According to Bankrate.com, cash-out mortgage refinance rates are around 3.7% APR in 2020. So if you need to lower your rate, it might make sense for you to do a cash-out refinance. While this is an option for many borrowers, lending criteria are becoming more strict. All lenders are looking more closely to see if someone is already in forbearance and whether borrowers have jobs, says CD Davies, head of lending at Figure. In the past, he says, verification of employment happened shortly after application. Now borrowers can expect verification of employment within 48 hours of closing.Evaluating whether to do a cash-out refinance will depend on a few things:
Consider A 401 Rollover
If you take a distribution from your 401 and roll it over to a qualifying IRA within 60 days, there are no taxes or penalties on the money transferred. Like an IRA rollover, this is an option for obtaining a short-term loan after retirement. If you already have an IRA, consolidating all your retirement funds in one account can be easier to manage. Just be sure to deposit all of the funds into the new IRA account in time to avoid taxes or an early withdrawal penalty if you are under age 59 1/2.
Read Also: How To Roll Your 401k From Previous Employer
Borrowing Against Your 401
So can you use your 401 to buy a house, and more importantly, should you? Yes, the money is technically yours so you can use it for anything you want or need it for, including as a 401 first-time home buyer.
While you can withdraw your money from the 401 plan in some cases, such as financial hardship, it can be more financially advantageous to borrow instead. But you do need to be aware of some of the potential downsides. Here are some questions to ask:
Does A 401 Loan Or Withdrawal Make More Sense
When you consider the potential tax consequences associated with an early withdrawal, a 401 loan may seem more attractive. Of course, there’s one drawback with both options: you’re diminishing your retirement savings.
With a 401 loan, you’d have the ability to replace that money over time. If you’re cashing out an old 401, however, there’s no way to put that money back. In both cases, you’re missing out on the power of compound interest to grow your retirement wealth over time.
One upside of deciding to borrow from a 401 for a housewhether you take a loan or make a withdrawalis that it may allow you to avoid paying private mortgage insurance if you offer the lender a large enough down payment. Private mortgage insurance protects the lender, and it’s typically required if you’re putting less than 20% down on a conventional mortgage. Private mortgage insurance can be eliminated when you reach 20% equity in the home, but it can add to the cost of homeownership in the early years of your mortgage.
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The New Rules Of Borrowing Money From Your 401 And Better Options To Consider
The COVID-19 pandemic has caused millions of people to lose their jobs or temporarily stop earning an income. The halt in cash flow means you or any of your friends and relatives cant afford basic necessities, like making home payments and buying food.
If there were no global pandemic, experts would be singing in unison to avoid borrowing money from your 401 or 403. But desperation and hardship are very real for millions of Americans. If youve emptied your emergency fund and your checking and savings accounts are exhausted, taking a 401 loan to cover current costs may be your next best alternative.
Heres what you need to know about 401 loans and taking out money from your retirement accounts before you retire.
Alternative Options For Securing Down Payments
Borrowing from your 401k can impact your retirement savings and cost you a lot of money if youâre unable to repay the loan, leave your job, or worse, canât afford your mortgage payment on top of your 401k loan payment.
Itâs best to explore other alternatives before deciding to withdraw from your 401k. Some other financing options include:
- IRA withdrawals – similar to 401ks, IRAs allow first-time home buyers to withdrawal $10,000 without penalty
- Find a starter home – if the home of your dreams is out of range right now, consider finding a less expensive home that better fits your budget and can be resold in 5-10 years
- Apply for an FHA or USDA loan – these loans only require 3.5% down payments, rather than the traditional 20%, making it easier for first-time buyers to secure funding
- Wait to buy a home – if you donât have enough savings to cover the down payment on a house, it might make sense to wait, add to your savings, and look again when you have more money available
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