Other Down Payment Funding Options
Taking money from your 401 either in loan or withdrawal form is not the only way to come up with money that you can use for a down payment on a house. Here are some other options that are available:
- FHA Loans
If you’re a first-time homebuyer, you can get an FHA loan to finance your home purchase. With an FHA loan, you will not have to put down 1020%. Instead, you can put a minimum of 3.5% down as long as your credit score is above 580.
- Gift From Friends or Family
If you have a generous friend or family member who is willing to help you out with a down payment, then this is a good option. Most lenders will allow gifts to be used for a down payment. However, the amount of gift money that can be used for the down payment may vary depending on the type of loan and the lender. Be sure to ask your lender what their policies are before you try to use a gift as a down payment.
One party that you are not allowed to get a gift from for a down payment is the seller. As Sullivan at HUD explains, “We have long prohibited that the sources of payment be the seller. It is critically important that there be separation between buyer and seller in the transaction. There was a time, for a while, when the FHA would insure mortgages where the buyer of the home was contributing a down payment that was financed by the seller. We found those loans to be incredibly risky and defaulted at a much greater rate. And so, we prohibited that practice.”
- IRA Withdrawals
- Assistance Programs
- Sell Assets
Can I Take Out My Money From My 401k
The IRS allows penalty-free withdrawals from retirement accounts after age 59 ½ and requires withdrawals after age 72 . There are some exceptions to these rules for 401ks and other qualified plans.
What reasons can you withdraw from 401k without penalty?
- Unreimbursed medical bills.
- If you owe the IRS.
- First-time homebuyers.
- Higher education expenses.
- For income purposes.
How much money can I take out from my 401k? With a 401 loan, you borrow money from your retirement savings account. Depending on what your employers plan allows, you could take out as much as 50% of your savings, up to a maximum of $50,000, within a 12-month period.
What happens when you withdraw from 401k?
If you withdraw money from your 401 account before age 59 1/2, you will need to pay a 10% early withdrawal penalty, in addition to income tax, on the distribution. For someone in the 24% tax bracket, a $5,000 early 401 withdrawal will cost $1,700 in taxes and penalties. Avoid the 401 early withdrawal penalty.
Do You Get Taxed On 401k After 65
Your tax depends on how much you withdraw and how much other income you have. The amount of a 401k or IRA distribution tax will depend on your marginal tax rate for the tax year, as set forth below the tax rate on a 401k at age 65 or any other age above 59 1/2 is the same as your regular income tax rate.
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Uses For The 401k Money
The IRS only allows you to use your money from the 401K for specific reasons. One of which is to purchase a principal residence. However, you have to prove that you do not have any other funds you can use for the down payment. For example, you cannot have a savings account with $10,000 in it just sitting there and expect to take money out of your 401K for the down payment.
The money you withdraw from your 401K must be used specifically for the down payment. You may only withdraw the amount you need for the down payment you cannot just keep the leftover funds. For example, if you must put $10,000 down on a home to purchase it, you may be able to withdraw $10,000 from your 401K. The only exception is if you need the money to pay the penalty and taxes on the money, which we will discuss below.
How To Use A 401 Loan To Buy A House
A 401 loan is the preferredmethod if you need to cash out some of your 401 retirementfunds tobuy a house. Thats because theres a much lower cost associated with a 401loan comparedto a 401 withdrawal.
You should also know:
- A 401 loan is usually not counted in your debt-to-income ratio, so it wont hurt your chances of mortgage qualifying
- 401 loans are not reported to credit bureaus, so applying for one wont harm your credit score
Can I use my 401k to buy a house without penalty?
Unlike a 401 withdrawal, a401 loan is not subject to a 10% early withdrawal penalty from the IRS. Andthe money you receive will not be taxed as income.
The rules for using a 401 loanto buy a house are as follows:
- Your employer must allow 401loans as part of its retirement plan
- The maximum loan amount is 50% ofyour 401svested balance or $50,000, whichever is less
- The loan must be paid back withinterest , on a schedule agreed to by youand your 401 provider
- Typically,you cannot make 401 contributions while you have an outstanding 401 loan
401 loans typically need to bepaid back over five years.
However, when the money is used topurchase a home, youre usually allowed to pay it back over a longer period oftime. Rules vary by 401 company, so check with yours to learn more.
Drawbacks to 401 loans for home buying
While youre paying back the 401 loan, you usually cant make new contributions to your retirement account. And that means your employer wont be matching contributions, either.
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Ways To Use Your 401k
First things firstlets go over the purpose of a 401K.
401Ks are retirement savings accounts. The government wants people to save for retirement, which is why it allows you to put a portion of your paycheck into your savings account without paying any taxes on that money. In turn:
- You are not supposed to make withdrawals until you are 59 ½ .
- Because these accounts are meant for retirement, there are penalties for early withdrawal.
- You will also have to pay taxes on any withdrawn funds.
However, your 401K account is ultimately filled with your money, and you can use it to buy a house, although doing so can result in a net financial loss.
Depending on the specifics of your plan, you may have two options for using the money: withdrawing it or taking out a loan against the funds. In both cases, there are 401K first-time home buyer IRS considerations.
Next, well take a closer look at the pros and cons of each method.
Should I Use My 401k To Pay Off My Mortgage When I Retire
At retirement, a very common question we are asked is, Should I use my 401k from work to pay off my mortgage when I retire? Getting rid of that monthly payment can seem like a great idea to lower your expenses during retirement. A lot of factors can determine if its a good idea or not, but lets examine the advantages and drawbacks a little further.
Note: When I use 401k I also want to include IRA/SEP/SIMPLE IRA etc., but Ill just use 401k going forward to simplify things.
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You Could Derail Your Savings Progress
It might be your goal to buy that house right now, but tapping into your retirement fund to make it happen might take you away from your future financial goals, experts say.
“By tapping even a small portion of your retirement nest egg early, you run the risk of derailing the progress you have made in saving for retirement in addition to the penalties and taxes incurred,” says Kenny Senour, a financial planner. “It’s true that you can begin to replenish the money you take out through your future paycheck deferrals, but it can take a long time to rebuild depending on how much is taken out.”
Financial advisor Jenna Lofton says you may also lose out on compound interest if you pull out a large chunk of your savings and take years to pay it back.
“If there was ever an investment where compound interest works in your favor, this is certainly one,” says Lofton. “These accounts are designed to have you living as comfortably post-retirement as you can envision yourself doing during pre-retirement.”
Buying A Home Is A Big Financial Investment And Even If You Dont Have The Cash To Purchase A Home Outright Youll Probably Still Need Money On Hand For A Down Payment
If you havent saved for a down payment, though, you might be considering other ways to get access to the money you need now, including your 401. Thats because some 401 plans let you borrow money from your retirement savings and pay it back over time.
But even if you arent planning to retire any time soon, taking a loan from your 401 can come with big drawbacks, like missing out on potential investment growth. So before you dip into your nest egg, consider if its really the best option for you.
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Make A 401 Withdrawal
Your second option would be to make a direct withdrawal from your 401 account. As mentioned above, this is the less desirable of the two options.
An early withdrawal would be classified as a hardship withdrawal. The IRS considers any emergency removal of funds from a 401 to cover an immediate and heavy financial need as a hardship withdrawal. Whether or not the purchase of a home using your 401 counts as a hardship withdrawal is a determination that falls to your employer, and you will need to present evidence of hardship before the withdrawal can be approved.
Regardless, you will still likely incur the 10% early withdrawal penalty. There are exemptions in place for specific circumstances, including home buying expenses for a principal residence. Qualifying for such exemptions is difficult by design, however. If you possess other assets that could be used for your home purchase, then you likely wont qualify for an exemption. Even if you do, your withdrawal will still be taxed as income.
Alternatives To Borrowing From Your 401
Before you borrow from a 401 to buy a home, consider whether there are other options available. For example:
- Down payment assistance programs: Down payment assistance programs are designed to help eligible buyers with down payment and closing costs. Some programs offer grants to qualified buyers that don’t have to be repaid. Others offer matching savings programs, similar to a 401, that match every dollar you save towards your down payment, up to a certain amount.
- Down payment gifts: If you have family members who want to support your efforts to buy a home, consider asking them to gift money for a down payment. The amount of money that can be gifted and the amount you have to put towards the down payment out of your own funds may vary based on the type of mortgage. The most important thing to remember with down payment gifts is that they must be thoroughly documented. Otherwise, the lender might not allow you to use those funds for your down payment.
- IRA withdrawal: If you have an IRA, you can withdraw up to $10,000 from your account towards a down payment on a home without incurring the 10% early-withdrawal penalty. Be aware that if you’re withdrawing from a traditional IRA, you’ll still owe income tax on the amount you withdraw.
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How Much Can You Withdraw From Your 401k For A Home Purchase
The maximum withdrawal amount varies depending on the method you use. Start with a 401 loan because it is the financially responsible choice. You can cover any remaining fees with a 401 withdrawal because of the 401s stricter loan requirements.
Due to a recent congress ruling, if your employer allows it, you are allowed to withdraw both your employers 401 contributions and any investment earnings as well as your contributions.
Benefits Of Borrowing From Your 401k To Buy A Home
The great thing about 401k loans is that they dont count towards your debt-to-income ratio. Using a 401k loan to finance your down payment can put you in a more favorable position for financing your mortgage. And, these loans are not reported to the credit bureaus, so they dont impact your credit score. It can also be beneficial to borrow from your 401k as a first time home buyer in order to make a higher down payment, especially in a competitive housing market. That said, you should consider the monthly payments on your 401k loan along with your monthly mortgage payment to ensure that these payments are within your budget.
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Ask For Money From The Seller
Whether or not you decide to pull from your 401 for your home purchase, if you truly feel that youre unable to afford the upfront costs of buying a home, it may be a good idea to ask for money from the seller. In this scenario, the seller will pay for a portion of your closing costs upfront and raise the sale price of the home accordingly, which will allow you to pay for your closing cost overtime in the form of a slightly- higher mortgage payment.
While this may sound like a good deal, its important to note that its usually not recommended to go this route unless its absolutely necessary. Often, asking for a seller concession makes your offer appear weaker in the eyes of the seller and may make you less competitive in a hot market.
Borrowing From Your 401
If you would like to borrow from your 401 to fund a home purchase, then you must do it through a “401 loan.” A 401 loan is a loan that lets you borrow a certain amount of money from your 401 at a set interest rate. As with a standard loan, the money that you borrow will have to be repaid within a certain period of time.
Not all 401 plans allow for loans, so the first thing you should do if you are thinking about taking out a 401 loan is to check with your employer to see if your plan permits loans.
A 401 loan has many advantages. First of all, it can be accessed quickly. In fact, in most circumstances, 401 loans can be obtained within a few days and just take a few clicks of a mouse to obtain.
So, if a house you love suddenly pops up on the market at a good price and you need cash immediately to buy it, a 401 loan may be an excellent option.
Another key advantage of 401 loans is that they typically do not require credit checks and lengthy applications. Why not? Because you are borrowing money from yourself, so you are the only party taking on risk. The loan origination fees for 401s also tend to be low compared with other types of loans. This is another nice benefit of 401 loans.
Additionally, unlike other types of loans, the interest that you pay back on your loan goes to you. You will not have to spend money making interest payments to a financial institution or to another lender.
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If You Have An Old 401k Here’s What You Can Do
So, your options for investing in real estate are rather limited if you have an active 401k, meaning that you still work for the sponsoring employer.
On the other hand, if you have an old 401k, the possibilities are much greater.
While you can’t invest in real estate directly through an employer-sponsored 401k, you can choose to roll a former employer’s 401k account into an individual retirement account, or IRA. And while many IRA custodians don’t offer the ability to buy real estate, some offer an account type known as a self-directed IRA.
As the name implies, a self-directed IRA allows you to direct how your funds are invested, within the law. To be sure, there are some things you can’t invest in. For example, the law prohibits you from investing in collectibles with IRA funds. However, there’s nothing that specifically prohibits you from using a self-directed IRA to buy real estate.
- Things youcan buy with a self-directed IRA: Real estate, crowdfunded real estate investments, tax lien certificates, precious metals, cryptocurrencies, private equity investments.
- Things youcan’t buy with a self-directed IRA: Collectibles, such as coins, artwork, and antiques.
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.
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