Pros And Cons Of Getting A Bridge Loan For A Down Payment
|You can tap equity while your home is listed for sale.||You may end up with two to three simultaneous mortgage payments.|
|You dont have to wait for your current home to sell to buy a new one.||Youll pay higher rates and closing costs.|
|Youll avoid moving twice since youre tapping equity to buy your new home before the old one sells.||Youll have to qualify with all of the mortgage payments, and could lose two homes if you default on the loans.|
Should You Borrow From Your 401 To Make A Home Down Payment
by Christy Bieber | Updated July 19, 2021 – First published on June 17, 2021
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You may regret making the choice to raid your retirement funds.
When you’re trying to buy a home, it’s best to make a 20% down payment. Doing so allows you to avoid having to buy private mortgage insurance . PMI ensures lenders don’t end up with out-of-pocket losses if they have to foreclose. Unfortunately you cover the expenses of PMI, although it provides you with no personal protection.
A 20% down payment is also useful because it:
- Makes it easier to get approved for a home loan
- Allows you to borrow less
- Saves you money on interest over time
- Makes it less likely you’ll end up owing more than your home is worth
Unfortunately, coming up with 20% down can be difficult for many home buyers. And, in fact, even finding the money for a smaller down payment can be a challenge if you’re in an expensive market.
If you decide now is a good time to buy a home but struggle to come up with the cash to make a down payment, you may be tempted to borrow against your 401. After all, if you have a lot of money sitting in this account, it may seem like an attractive source of funds that could solve your down payment issues.
Weighing Pros And Cons
Before you determine whether to borrow from your 401 account, consider the following advantages and drawbacks to this decision.
On the plus side:
- You usually dont have to explain why you need the money or how you intend to spend it.
- You may qualify for a lower interest rate than you would at a bank or other lender, especially if you have a low credit score.
- The interest you repay is paid back into your account.
- Since youre borrowing rather than withdrawing money, no income tax or potential early withdrawal penalty is due.
On the negative side:
- The money you withdraw will not grow if it isnt invested.
- Repayments are made with after-tax dollars that will be taxed again when you eventually withdraw them from your account.
- The fees you pay to arrange the loan may be higher than on a conventional loan, depending on the way they are calculated.
- The interest is never deductible even if you use the money to buy or renovate your home.
CAUTION: Perhaps the biggest risk you run is leaving your job while you have an outstanding loan balance. If thats the case, youll probably have to repay the entire balance within 90 days of your departure. If you dont repay, youre in default, and the remaining loan balance is considered a withdrawal. Income taxes are due on the full amount. And if youre younger than 59½, you may owe the 10 percent early withdrawal penalty as well. If this should happen, you could find your retirement savings substantially drained.
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Get A Loan From A Friend Or Family Member
Tapping a friend or family member for your down payment is another option. However, private mortgage loans from family have to be secured by an asset, like real estate, artwork or an automobile, to be acceptable to your new mortgage company. Youll have to qualify with the new payment, so be sure to discuss the terms with your loan officer when youre getting your mortgage preapproval.
Document the following items if you go down this borrowing path:
- The terms of the loan including the loan amount, repayment term and monthly payment.
- A statement from the friend or family member saying that they have no interest in the home youre buying.
- Evidence youve received the funds from them.
- Proof of the asset the loan is secured by.
If you have a family member willing to gift you money for your down payment, you can use those funds as long as theyre willing to sign a gift letter confirming no repayment is expected. Youll also need to provide paperwork showing the money going from your relatives account into yours.
When Does Using A 401 For Down Payment Make Sense
The decision to go into your 401 for down payment money should only be made after careful analysis. You first need to check with your plan administrator to see if its allowed. Not all companies that maintain 401 savings plans offer a borrowing option. If its permitted, its time to explore all alternatives before deciding what makes sense.
Using a 401 generally only works in your favor if the money is used to avoid paying for private mortgage insurance on your home loan. Most conventional home loans require that you obtain and pay extra for mortgage insurance if your down payment is less than 20% of a propertys purchase price. Mortgage insurance typically costs 0.5% to 1% of the total value of the loan on an annual basis and must be paid each month until you reach achieve 20% equity in your home.
Before shopping for a home, use online tools or meet with a mortgage broker to determine how large a loan and down payment you can afford. Buying a home that you might struggle to afford could become a financial disaster, so its important to know what sort of mortgages are available and how much they will cost you a month based on current interest rates. Mortgage insurance is part of the equation if you cant cover a standard down payment.
Not all loans require mortgage insurance for down payments of less than 20%.
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What Happens If You Leave Your Job
When you take out a loan from a 401, you may have no intention of leaving your current employer. But if you receive a better job offer, or are laid off or otherwise leave, you could be required to pay the loan back in full or face some serious tax consequences.
Employees who leave their jobs with an outstanding 401 loan have until the tax-return-filing due date for that tax year, including any extensions, to repay the outstanding balance of the loan, or to roll it over into another eligible retirement account. That means if you left your job in January 2020, you would have until April 15, 2021 when your 2020 federal tax return is due to roll over or repay the loan amount. Prior to the Tax Cuts and Jobs Act of 2017, the deadline was 60 days.
If you cant repay the loan, your employer will treat the remaining unpaid balance as a distribution and issue Form 1099-R to the IRS. That amount is typically considered taxable income and may be subject to a 10% penalty on the amount of the distribution for early withdrawal if youre younger than 59½ or dont otherwise qualify for an exemption.
Unfortunately, this worst-case scenario isnt rare. A 2014 study from the Pension Research Council at the Wharton School of the University of Pennsylvania found that 86% of workers in the sample who left their jobs with a loan outstanding eventually defaulted on the loan.
Better Options For Emergency Cash Than An Early 401 Withdrawal
We know it can be a struggle when suddenly you need emergency cash for medical expenses, student loans, or crushing consumer debt. The extreme impact of coronavirus on public health and the economy has only compounded some of the more routine challenges of consumer cash flow.
We get it. The money squeeze can be quick and traumatic, especially in a more volatile economy.
Thats why information about an early 401 withdrawal is among the most frequently searched items on principal.com. Understandably so, in a world keen on saddling us with debt.
But the sad reality is that if you do it, you could be missing out on crucial long-term growth, says Stanley Poorman, an advice and planning manager for Principal® Advised Services who helps clients on household money matters.
In short, he says, Youre harming your ability to reach retirement. More on that in a minute. First, lets cover your alternatives.
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How To Use Your 401k To Buy A House
Buying a home is one of the biggest purchases youll make in your lifetime. If youre like many homebuyers, you may not have abundant amounts of cash lying around to make a substantial down payment. However, the larger your down payment, the lower your monthly mortgage payments will be. For this reason, you might consider borrowing from your 401k for down payment funds.
Why Do People Get 401 Loans
As long as a plan allows it, participants generally can borrow from their 401 for any reason. Some plans may only allow loans for specific reasons, so be sure to check your plans rules before trying to borrow.
Since youre borrowing your own money, and no credit check is involved, it may be easier to get approved for a 401 loan as long as you meet the plans requirements for borrowing. In some cases, a requirement may be getting approval from your spouse , because your spouse may be entitled to half of your retirement assets if you divorce.
Here are some potential uses for a 401 loan.
- Paying household bills and expenses
- Funding a down payment on a house
- Paying off high-interest debt
- Paying back taxes, or money owed to the IRS
- Funding necessary home repairs
- Paying education expenses
But that doesnt mean 401 loans are always a good idea. In fact, there are some major risks that come with borrowing from your retirement savings. Here are two.
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If Im Considering A 401 Loan What Information Should I Get From My Plan Provider
If youre considering taking a loan from your 401, ask your plan administrator for the following information:
- Whether or not loans are/are not permitted
- The minimum dollar amount required to obtain a loan
- The maximum number of loans permitted by the plan
- The maximum dollar amount permitted
- The term of repayment
- Any interest rate information
- Any required security for the loan
- How repayment may be made
- Any spousal consent requirements
Alternatives To Withdrawing From Your Retirement Fund
Keep in mind there are alternative financing methods that can help you leave your retirement savings intact. Think about utilizing one of these four methods so you don’t have to disrupt your retirement fund.
1. Withdraw from your IRA
Even though your IRA is still retirement savings, there may be advantages to choosing this investment vehicle over your 401k. In particular, if your Roth IRA plan allows for hardship withdrawals, you’re allowed to withdraw any amount. However, even if hardship withdrawals are not allowed under your plan, as long as you’re a first-time homebuyer, you can withdraw up to $10,000 tax-free to go toward your down payment.
On the other hand, if you have a traditional IRA, you also have the option of taking out up to $10,000 to go toward your down payment. You won’t be required to pay any early withdrawal penalties on this money, but it will be taxed as income. If you take out a distribution larger than $10,000, you will pay a penalty and regular income tax on that amount.
2. Take out a personal loan
Typically, acceptance for personal loans is based on your income and . While every lender is different, in some circumstances, it’s possible to take out up to $100,000 to put toward a down payment.
3. Ask for a gift
4. Use a down payment assistance program
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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.
What Are The Cons
Besides the fees, your employer will likely stop their side of the match, if they were making one. Even when youre paying yourself back, they wont consider those funds a new contribution and therefore wont match it. It also might make it more difficult to qualify for a mortgage, as it can affect your debt-to-income ratio, but be sure to shop around to find a lender who will offer you the best program that fits your financial needs. And of course, youll lose out on the compound interest your money would have been earning if youd left it in the account.
Of course, if you decide to withdraw rather than borrow from your 401, the main con is the giant tax hit you will suffer.
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To Make A Down Payment On A Home
Buying a home is a big expense, and as a result, more than 10% of Americans have dipped into their retirement savings in order to make a down payment on their first home, according to Bankrate.
That’s not necessarily a bad thing: “There are certain circumstances in which taking a 401 loan might make sense, such as making a down payment on a home, which is a worthwhile financial goal in its own right,” Golladay says.
If you choose this option, it’s importantto “ensure the size of the loan doesn’t keep you from continuing to save for retirement,” Golladay says. You want to be able to keep saving in addition to paying back the loan.
When determining how large of a loan to take, “less is more,” says Ryan Marshall, a New Jersey-based certified financial planner. “The maximum 401 loan amount generally is 50% of the vested balance or $50,000, whichever is less,” he explains. However, “I would say try to keep it to 10% of the portfolio or $10,000.”
Another thing to take into account is the housing market. In general, you should always ask yourself whether you’re planning to buy within “a favorable market for purchasing real estate,” Golladay says. Is it worth buying now, or should you keep saving up as you wait for better market conditions?
Get A Gift From A Loved One
Another alternative to using a 401 to buy a house is to ask for a gift from a loved one. Gift money can be used for a down payment as long as the lender can verify the source of the funds and the person giving the gift submits a statement that says the money is truly a gift and not a loan.
While parents typically give their children gifts, depending on your loan program, the gift may be able to come from another source. For instance, Fannie Mae allows gift funds to come from an immediate family member, fiancé or domestic partner, while the FHAs list includes family members, employers, close friends and charitable organizations, as well as organizations or agencies providing homeownership assistance.
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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.
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.
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