What Are The Borrowing Limits For A 401
In general, you can only borrow up to 50% of your vested account balance or $50,000, whichever is less. Some plans may offer an exception if your balance is less than $10,000 you may be allowed to withdraw the entire amount. With a withdrawal, there are no limits on the amount, assuming your plan allows you to do so.
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.
Down Payment And Closing Cost Assistance
What if you dont have a 3% down payment? After all, 3% of $300,000 is $9,000 thats still a lot of money.
If you need help making your down payment, there are other places to turn before your 401. For example:
- Look for down payment assistance programs in your area.DPA programs are available in every state. They offer grants and low-interest loans to help home buyers cover their down payment and closing costs. If you need help buying a house, DPA should be the first place you turn
- Look for mortgage lenders that offer down payment or closing cost help. Some lenders have special programs that offer credits to cover part of your down payment and/or closing costs. Find a few examples in our list of the best lenders for first time home buyers
- Ask a relative or family friend for help. Some home loans allow you to cover your entire down payment and closing costs using gifted money, although this must be properly documented. Make sure your real estate agent and loan officer know if you plan to use gifted funds
Most of these programs are specifically designed for first-time, lower-income, or lower-credit home buyers. So if youre having trouble saving for a down payment for any of these reasons, theres a good chance you could qualify.
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Withdrawals From Your 401k Will Incur Penalties
The first major issue with using your 401k to buy a house is the penalty. If you are withdrawing these funds to cover a home purchase before age 59.5, the transaction will qualify as an early withdrawal.
As an early withdrawal, the IRS will impose a 10% penalty on the funds. Thats a steep penalty! Unfortunately, that is money youll never get back. And it can add up quickly. Lets say you decide to take an early withdrawal of $10,000. Thats a $1,000 penalty right there.
Since saving $1,000 is a lot of money for anyone, the downside of these penalties is that you lose a substantial percentage of the money you worked so hard to save.
Should I Make A 401 Withdrawal Instead
Withdrawing money from your 401 before retirement, as opposed to borrowing from it, is usually a bad financial move. Not only will you be taking the money that youve invested for your golden years leaving you with less for retirement you may be hit with an early-withdrawal penalty.
Unless youre 59½ or qualify for another exception, youll have to pay tax on the amount you withdraw plus a 10% penalty. Though that penalty may be waived on up to $10,000 withdrawn from a traditional, SIMPLE or Roth IRA if you use the money to buy, build or rebuild your first home.
If youre experiencing financial hardship, your plan may offer the option of a hardship withdrawal. Youll still need to pay tax on the withdrawal amount, and you may also need to pay the 10% penalty. But the amount you take for a hardship withdrawal cant be paid back to your retirement plan like a 401 loan can.
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What Is The Difference Between A 401 Loan And A 401 Withdrawal
When you withdraw money from your 401, you have to pay income taxes on the amount you withdraw and you may also have to pay a 10% early withdrawal penalty if you are not at least 59½ years of age. Unlike a 401 loan, you do not have to repay a 401 withdrawal, which can make this type of funding sound good to first-time homebuyers. Remember, though, the money you withdraw will no longer be there for you at retirement.
If your 401 is the only funding source you have, then you might consider buying your home using a 401 loan instead of a 401 withdrawal. Before considering this option, however, remember to check to see if your 401 plan allows for a loan. These often allow you to borrow up to half the value of your vested balance, and repay yourself, with interest. While most 401 loans require repayment within 5 years, for some first-time homebuyers, that period may be extended.
Do You Qualify For A Mortgage Without 401 Funds
With such a wide range of mortgageoptions and down payment assistance on the market, most people simply dontneed to tap their 401 in order to purchase a home.
On top of that, todays lowmortgage rates increase your home buying power by reducing monthly payments.Its easier to afford a home than ever before.
Before taking money out ofretirement, find out whether you qualify for a mortgage based on your currentsavings. You might be surprised.
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When A 401 Withdrawal Might Make Sense
Despite the downsides, some homebuyers may decide that the benefits of early 401 withdrawal outweigh the risks. If you choose to leverage funds from your retirement savings to help afford a home, you may qualify for a hardship withdrawal status. This means you could access your money penalty-free and avoid the 10% fee While penalty-free access means you save a nice amount when accessing your funds, a hardship withdrawal can never be repaid into your 401you would be forfeiting that amount from your retirement savings altogether.
According to the IRS, a hardship withdrawal exemption must be proven to be used for an immediate and heavy financial need. Costs directly related to the purchase of a principal residence are sometimes considered an allowable exemption.
You may only withdraw the amount necessary to satisfy the immediate need and if you have any other assets that could technically be put toward a down payment, youre unlikely to be approved for hardship exemption. Even if your withdrawal does qualify for exemption status , youll still face income tax on the total amount withdrawn.
Who Gets The Interest Payments From A 401 Loan
You get the interest you pay on the 401 loans, since you are essentially lending money to yourself. Keep in mind that the interest payments are made with after-tax dollars. That’s a downside to 401 loans, because those after-tax dollars will be taxed again when they’re taken out as a 401 withdrawal in retirement.
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You Can Also Borrow From Your 401 But There Are Downsides
According to Quicken Loans, you can often borrow from your 401generally up to 50 percent of your vested account balance or $50,000, whichever amount is lessalthough the company advises checking with your employer or HR department to determine whether your 401 plan even allows loans.
The company also notes that youll have an allotted time for repaying the loan, which is usually within five years. Youll pay interest on the loan, which is often 2 points over the prime rate. The loan might impact your debt-to-income ratio and make it harder to get a mortgage.
However, there are upsides. Quicken Loans said, Besides allowing you to make a purchase you might otherwise not be able to make, borrowing from your 401 is basically borrowing from yourself, rather than another lender. That means that you might not be losing as much money on interest payments as you would if you got the funds via another means.
Is It A Good Idea To Use Your 401k To Buy A House
Before we jump into how to invest your 401k in real estate, letâs answer one important question. Itâs possible to use 401k money in real estate investing, but is it actually a good idea to do so? Here are the pros and cons to consider:
Advantages of Investing Your 401k in Real Estate
When mortgage interest rates rise, a 401k loan can provide cost-effective access to money. With interest rates just above the prime rate on most 401k loans, this can be an affordable option to cover a large down payment on an investment property. And while weâre on the subject of interest, hereâs another benefit of borrowing from your 401k for a down payment: as you pay back your 401k loan, youâre repaying yourself with interest which is going back into your 401k account.
Finally, another reason why you might want to invest your 401k in real estate is the tax exemption that comes with 401k loans. When you borrow from your 401k, there are no tax consequences and no tax-related fees. For example, when you withdraw from an IRA to put a down payment on an investment property, youâll have to pay income taxes on the distribution. However, because the money you borrow from your 401k is a loan, you donât need to pay income taxes on it. As a matter of fact, it doesnât count as income at all.
Disadvantages of Investing Your 401k in Real Estate
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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, theres one drawback with both options: youre diminishing your retirement savings.
With a 401 loan, youd have the ability to replace that money over time. If youre cashing out an old 401, however, theres no way to put that money back. In both cases, youre 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 its typically required if youre 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.
Home Loans With Low Minimum Down Payments
Be sure youre aware of all your mortgage options. Some home loan programs have no or low minimum down payments. For example, VA and USDA borrowers can purchase a home with no money down. FHA loans require only a 3.5% down payment, and some conventional loans have a 3% minimum down payment.
Do you need help weighing the pros and cons of 401 withdrawals for a home purchase? A local Finance of America Mortgage Advisor can help you explore your options.
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Consider Using Roth Ira Withdrawals Instead
If you decide to use retirement funds to help buy a home, consider using money saved in a Roth IRA instead of a 401 or traditional IRA. Because Roth IRA contributions have already been taxed, youll have an easier time accessing this money.
Also, since money in your IRA isnt connected to your employer, you wont face a faster repayment period if you change jobs.
The Bottom Line: Find The Mortgage Option Thats Right For You
Your 401 account may seem tempting as an untapped source of cash, especially if youre struggling to come up with the money for a down payment on your new home. While this is a viable option, and there are ways to mitigate the penalties, it should only be used as a last resort. Consider applying for a low down-payment loan like an FHA or VA loan, or, if you have one, making a withdrawal from your IRA.
Whatever you decide, make sure you consult with a mortgage specialist before committing to an option. Rocket Mortgage® has experts waiting to help you navigate the tricky waters of home loans. If youre ready to take that next step toward a mortgage, then get preapproved today.
Take the first step toward the right mortgage.
Apply online for expert recommendations with real interest rates and payments.
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Build An Emergency Fund
This should be the foundation of your financial plan and experts recommend having about six months worth of expenses saved. You can park this money in a high-yield savings account to earn more interest than you would in a traditional checking account. An emergency fund should help you manage most of lifes curveballs.
Find The Mortgage Option Thats Right For You
Your 401 account may seem tempting as an untapped source of cash, especially if youre struggling to come up with the money for a down payment on your new home. While this is a viable option, and there are ways to mitigate the penalties, it should only be used as a last resort. Consider applying for a low down-payment loan like an FHA or VA loan, or, if you have one, making a withdrawal from your IRA.
Whatever you decide, make sure you consult with a mortgage specialist before committing to an option. Rocket Mortgage® has experts waiting to help you navigate the tricky waters of home loans. If youre ready to take that next step toward a mortgage, then get started with our experts today.
Take the first step toward the right mortgage.
Apply online for expert recommendations with real interest rates and payments.
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Does This Plan Really Make Sense In The Long Term
PMI typically costs about 0.5% to 1.5% of the loan amount, annually. On a $250,000 home loan, a 1% PMI premium would add $2,500 a year or about $208 a month to your mortgage payment.
Yes, thats a lot of money. But PMI also has a great return on investment. Considering the equity youll build through homeownership, you could see a return on investment of over 500% all while leaving your retirement savings account untouched.
Q: When Would You Recommend Not Using A 401k Loan To Finance Home Remodeling Or Repairs
DistilledDollar: If you plan on leaving your employer soon, then taking out a 401k loan will not help you. Once you are either terminated from your employer or leave voluntarily, you must repay the remaining balance of the loan within 30 to 60 days, depending on your employer.
Another scenario where I would not recommend a 401k loan is if you are nearing the age of 59 1/2. The amount of time you have to repay your loan is diminished. If you take out a 401k loan and are unable to repay by 59 1/2, then you will need to pay regular income taxes in addition to the 10% early withdrawal penalty.
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Look At Current And Future Finances Now
If you are thinking about buying a second home, then the first step is to take inventory of your current and future finances. Be sure to determine the in order to evaluate how much you can afford. Are you planning on using the second home as a rental during part of the year? If so, then dont count on that rental income as part of your income. After all, you never know if you are going to have a period without a renter. After undertaking this assessment, you will then have a better sense of what you really can afford.
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Should I Use 401 Funds To Avoid Pmi
Most homeowners who put less than 20% down on a conventional loan pay ongoing private mortgage insurance to secure the loan.
You could see mortgage insurance as just another expense of owning a home along with property taxes, homeowners insurance, and maintenance.
But since mortgage insurance protects the lender and not the borrower, many home shoppers think they must avoid PMI at any cost.
Some home buyers resort to emptying their savings accounts, pulling from their 401, or making IRA withdrawals to gather enough money for a 20% down payment and bypass the PMI requirement.
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What Happens If You Default On A 401 Loan
When you default on a 401 loan, it’s usually treated as an early withdrawal. Each plan can set its own rules, so you should check with your 401 company to see whether it handles the situation differently. When the remaining loan balance is reclassified as a “deemed distribution,” you will owe all the penalty and income taxes you would owe on any early 401 withdrawal.
Alternatives To Using Your 401
If you have plenty of time before you plan on buying a house, it may be a better option to try to save up for the down payment so that you donât have to dip into your retirement savings. It could even be better for your retirement savings to stop your 401 contributions for a couple of years so that you can save up for the down payment on a house and avoid taking any withdrawals from your retirement savings. This way, your 401 can continue to grow even if you briefly stop contributing.
Another alternative to using your 401 is to use an IRA. If you do have an Individual Retirement Account , you should know that the IRS allows you to take up to $10,000 from your account to purchase a house without any penalty. If you do not have an IRA, you can rollover your 401 funds into an IRA, but this is only possible if you are no longer employed with the company that provided your 401 plan.
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