Should You Borrow From Your 401k To Buy A House
Here’s what you need to know before borrowing from your 401k to buy a house.
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Many first-time homebuyers and investors who struggle to come up with the funds for their down payment and closing costs wonder if they should borrow from their 401k to cover these costs. While it is possible to borrow from your 401k to buy a house, it isn’t always advisable. This money is meant to be spent in retirement, and borrowing it early can get tricky.
Still, if you think this might be the best option for you, we’ve taken a deep dive into the two ways to borrow from a 401k: taking out a loan and doing a withdrawal. Below are the pros and cons of each method, as well as some alternative financing options to consider. Armed with this knowledge, you should be able to decide whether borrowing from your 401k is the right choice for you.
Should You Invest Your 401k In Real Estate How
Do you want to get into the real estate investing boom but donât have the liquid cash to start? If so, youâre most likely considering the many financing options available to beginner real estate investors. One of the most common financing options is mortgage loans, but this is not the ideal option for everyone as there are requirements that can limit some investors. If you canât get a mortgage, consider other options for buying an investment property before giving up! For example, did you know that you can invest your 401k in real estate? Whether you want to buy a house for personal use or for rental income, read this to learn how your 401k can be a funding source to invest in real estate.
Related: Real Estate Investment Financing: 7 Ways That Work for Beginners
Can You Take Money Out Of An Ira To Buy A House
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Can I withdraw all my money from my IRA at once? The magic ages of 59 1/2 and 70 1/2 Once you reach this age, you’re allowed to withdraw as much money as you want from your IRA without penalty. There’s no monthly limit, but you have to keep in mind that traditional IRA distributions will always be subject to income tax.
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Can I Use My 401 To Buy A House
For many would-be homeowners, the down payment is the biggest entry barrier to buying a house. While down payments can be as low as 3.5%, 20% is ideal if you want to secure a mortgage without monthly mortgage insurance fees.
If youre having trouble gathering funds for a down payment, you might find yourself considering using your 401 retirement fund as a convenient source of cash. While this is technically allowed, and could help you cover your down payment, there are some factors and drawbacks that you might want to consider.
Well break down the pros and cons of making a 401 withdrawal for a home purchase, as well as some alternatives.
How Much You Can Withdraw
You cant just withdraw as much as you want it must be the amount necessary to satisfy the financial need. That sum can, however, include whats required to pay taxes and penalties on the withdrawal.
The recent reforms allow the maximum withdrawal to represent a larger proportion of your 401 or 403 plan. Under the old rules, you could only withdraw your own salary-deferral contributionsthe amounts you had withheld from your paycheckfrom your plan when taking a hardship withdrawal. Also, taking a hardship withdrawal meant you couldn’t make new contributions to your plan for the next six months.
Under the new rules, you may, if your employer allows it, be able to withdraw your employers contributions plus any investment earnings in addition to your salary-deferral contributions. Youll also be able to keep contributing, which means youll lose less ground on saving for retirement and still be eligible to receive your employers matching contributions.
Some might argue that the ability to withdraw not just salary-deferral contributions but also employer contributions and investment returns is not an improvement to the program. Heres why.
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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.
How To Borrow From Your 401k Account
To borrow from your 401k loan to finance a down payment, youll need to talk to your employers benefits office or HR department, or with your 401k plan provider. You can also consult your plan document to find out if your plan permits borrowing from your 401k to purchase a home.
Youll want to find out how much youre able to borrow, the interest youll have to pay, and the repayment period. Additionally, ask about repayment options, such as whether your employer will deduct the monthly payment from your paycheck or if they will allow you to make 401k contributions while you pay back the loan.
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How Does A 401k Loan Work
A 401k loan gives you the option to borrow money from your retirement savings and repay it, with interest, over time. Your 401k loan rules may differ, but you can typically borrow up to $50,000 or half of your vested balance whichever is less with five years to pay it off. When you pay back the loan plus interest, that money goes back into your 401k, so you’re simply paying yourself back.
A 401k loan is different from a 401k withdrawal. In most cases, when you make an early withdrawal from your 401k before age 59½ you pay income taxes and a 10% penalty. A 401k loan lets you borrow money from your 401k penalty and tax-free, although you do have to pay it back.
Payments are usually made in the form of payroll deductions, making it easy to stay on top of the loan. If you’re unable to pay off your 401k loan on time, the remaining balance will be taxed as a withdrawal. If you’re below retirement age, you’ll also pay the 10% penalty.
Make Sure You’re Buying A Home For The Right Reasons
“Don’t buy real estate because rates are down or because of the pandemic buy real estate because it’s the best choice for you,” Roberge says.
Low interest rates don’t always add up to savings in your pocket. Over half of home offers tracked by Redfin in August were part of a bidding war, which can mean that the overall cost of the home is higher. While the interest rate may be low, if you’re paying a higher price overall to secure the home you want, it could end up costing you more in the long run.
If you’re considering buying a home in the current market, look at your savings levels before you browse listings, Roberge recommends. Do you have your cash reserves for emergencies set aside, plus money available for a down payment outside of your retirement savings?
“If not, it’s probably not a good idea to raid your 401 in order to make that down payment,” he says. That’s because when you take money out of your retirement accounts, it doesn’t “magically grow back,” Roberge says. “It’s money you’ve removed that you’ve worked so hard to save. By putting that money into real estate, it’s a coin flip on whether that’s going to be a good investment or not.”
When you’re buying a home to live in, it’s not an investment in the same sense as buying stocks, Roberge says. “It’s looked at as a utility. It’s a place to live…You’re building equity, which is a fantastic thing. But it’s not this secret solution that’s going to magically make your financial life better,” he says.
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Be Mindful Of These Restrictions
Its always a good idea to maintain regular communication with your custodian or CPA to ensure you dont violate some of the rules surrounding SDIRAs.
A good rule of thumb is to treat your SDIRA like any traditional retirement account. Funds and assets are there to grow tax free over time for you to use in your later retirement. Your SDIRA cannot pay or directly benefit you, your spouse, heirs, immediate family members, or business you own.
For the purposes of land, this means your SDIRA cannot buy parcels from your parents or spouse, sell them to your children, etc. Your business cannot buy a property and then transfer it to your SDIRA or vice-versa.
What you can and should do is use your SDIRA to buy and sell land from non-disqualified people and entities, and enjoy the tax benefits.
If youre not sure about something, again, talk to your custodian or CPA. Thats what theyre there for.
Qualifying For The 401k Hardship Withdrawal
Under normal circumstances, you cannot withdraw from your 401K until you are 59 ½. The only exception to the rule is if you take out a 401K loan. The 401K withdrawal, however, is not a loan. It is a permanent withdrawal of the money. In order to qualify, you must prove some type of hardship. A few examples include losing your job and still trying to recover or being unable to work due to a medical condition.
Each plan administrator has different requirements regarding the proof of a hardship. Talk to your employers HR department about what you need to provide. Basically, you will have to prove you do not have any other money and explain why. Your reasons must be able to be proven so the HR department can approve your request to withdraw the money early.
Read Also: How To Take Money From 401k Without Penalty
K Loan: Pros And Cons
The first way to borrow from your 401k is to take out a loan. As the name suggests, some of this method involves borrowing the money temporarily and then paying it back with interest over time. We’ve listed the pros and cons of choosing to take out a loan so you can get a better idea of how this process works.
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What Hardship Withdrawals Will Cost You
Hardship withdrawals hurt you in the long run when it comes to saving for retirement. You’re removing money you’ve set aside for your post-pay-check years and losing the opportunity to use it then, and to have it continue to appreciate in the meantime. You’ll also be liable for paying income tax on the amount of the withdrawaland at your current rate, which may well be higher than you’d have paid if the funds were withdrawn in retirement.
If you are younger than 59½, it’s also very likely you’ll be charged at 10% penalty on the amount you withdraw.
Use An Individual Retirement Account
Another option is to withdraw money from an individual retirement account, or IRA. Similar to a 401, youll pay a 10 percent early withdrawal penalty and income tax on the withdrawal.
The difference, though, is that first-time homebuyers can withdraw up to $10,000 without paying the early withdrawal penalty.
You’re considered a first-time homebuyer if you haven’t owned a principal residence in the past two years.
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Still Not Sure Ask A Financial Advisor
For most home buyers, withdrawing or borrowing from 401retirement funds to make a down payment on a house is short-sighted.
But your personal finances may create an exception. For somepeople, a hardship withdrawal or 401 loan could be a sensible solution.
A financial planner can help you weigh your current accountbalance against your long-term financial goals so you can better decide how toproceed.
Consider using a Roth IRA instead
If you decide to use retirement funds to help buy a home, considerusing money saved in a Roth IRA instead of a 401 or traditional IRA. BecauseRoth IRA contributions have already been taxed, youll have an easier timeaccessing this money.
Also, since money in your IRA isnt connected to your employer, youwont face a faster repayment period if you change jobs.
How Much Home Can You Actually Afford
Sometimes a bank will give you a loan for more house than you really want to pay for. Just because a bank says it will lend you $300,000 doesnt mean that you should actually borrow that much. Many first-time homebuyers make this mistake and end up house-poor with little left after they make their monthly mortgage payment to cover other costs, such as clothing, utilities, vacations, entertainment, or even food.
In deciding how big a loan to actually take, youll want to look at the houses total cost, not just the monthly payment. Consider how high the property taxes are in your chosen neighborhood, how much homeowners insurance will cost, how much you anticipate spending to maintain or improve the house, and how much your closing costs will be.
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Financing A Home With Debt Creates Both Leverage And Risk
A mortgage is inherently neither right nor wrong. However, it amplifies your risk, for better or worse. You’ll be controlling a large asset with the help of other people’s money, which is great if the asset appreciates, but can be disastrous if the opposite happens. Even someone with a high net worth can lose big by borrowing too muchor in financial terms, being too highly leveraged.
For simplicity, let’s say you have a net worth of $100,000 and you invest it all in the down payment on a $500,000 house. If the home’s value drops 20% the next day, you suddenly have a zero net worth and your life’s savings is gone .
On the other hand, if the home appreciates 20%, you’ll have doubled your net worth in one daya 100% return overnight.
Such is the nature of leverage.
The ultimate question is “How certain do I want to be to achieve a particular financial outcome?” The more certainty you require, the less leverage you’ll want to use. If you’re like most people, you’ll want to use less leverage as you age, because your appetite for uncertainty and extreme outcomes has diminished. This isn’t exactly the point in your life when you want to find a new job in another city and start over.
However, some people are comfortable with a large mortgage, even in retirement. It allows them to invest more outside the walls of their home. And it’s a strategy that worksuntil it doesn’t.
Drawbacks To Tapping Your 401
There are a few scenarios where tapping your 401 for a down payment might make sense. For instance, you might consider it if you want to:
- Capitalize on rapidly appreciating home values and/or low interest rates
- Build equity sooner
- Obtain a more affordable mortgage payment
- Secure a home before youre priced out of the market
However, its generally not recommended to use your 401 funds to buy a house, even if the situation appears ideal.
Whether youre borrowing from your plan or taking a hardship distribution, the decision could have an enduring impact on your retirement savings.
If youre taking out a 401 loan, you might miss out on years of additional contributions and employer matching.
And, if you lose or leave your job, you might have to quickly repay the rest of your loan to avoid having it count as an early distribution thatll be taxed and penalized.
Learn More: How to Save for a Down Payment on a House
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Taking Control Of Your Retirement Funds
You can take any personal 401k or IRA and turn it into an SDIRA. In order to do so, youll need the help of a custodian. I personally use Advanta, but theres plenty of custodians to choose from. BiggerPockets keeps a running list here. If youre a member of your local real estate investors association , ask around as its likely folks there are already leveraging the power of an SDIRA.
Your custodian makes purchases for you in a standard SDIRA, but if youre looking for more direct control, then ask your custodian about how to set up a checkbook IRA/SDIRA. In this scenario, your SDIRA controls a single member LLC with you as its designated manager. This LLC then operates just like any other business, taking care not to violate some of the key restrictions the IRS has for these self-directed accounts.