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?
Alternative To Borrowing From 401k Or Ira To Buy A Home
Instead of borrowing from your 401k or IRA to buy a home, youre much better off building your after-tax savings and investments that can provide for a 20% downpayment. If you dont have at least a 20% downpayment in cash plus a buffer equal to 10% of the value of the house, you probably cannot afford to buy your first home.
Leverage is great on the way up, but terrible on the way down.
Renting is good value now in many parts of the country, especially if you live in an expensive coastal city. Take a look at my BURL strategy if you really want to invest in real estate.
The pandemic hit tiger cities like San Francisco, San Jose, DC, and New York City harder than 18-hour cities. Therefore, renting in big cities is a good deal.
For example, if it sounds absurd to pay $4,200 a month in rent for a two bedroom, two bathroom apartment in San Francisco, it is even more absurd to spend $1,350,000 buying the place!
At $1,350,000, the apartment is trading at 26X annual gross rent or just a 3.6% gross yield. After property tax and expenses, were talking under a 3% net rental yield , and thats assuming no mortgage!
However, buying real estate in big cities is a relatively better deal nowadays. Therefore, if you have been waiting to buy in places like New York City or San Francisco, the time is now as rents tick back up post pandemic.
What Else Do I Need To Know
- If your employer makes contributions to your 401 plan you may be able to withdraw those dollars once you become vested . Check with your plan administrator for your plan’s withdrawal rules.
- If you are a reservist called to active duty after September 11, 2001, special rules may apply to you.
Important Note: Equitable believes that education is a key step toward addressing your financial goals, and this discussion serves simply as an informational and educational resource. It does not constitute investment advice, nor does it make a direct or indirect recommendation of any particular product or of the appropriateness of any particular investment-related option. Your unique needs, goals and circumstances require the individualized attention of your financial professional.
Equitable Financial Life Insurance Company issues life insurance and annuity products. Securities offered through Equitable Advisors, LLC, member FINRA, SIPC. Equitable Financial Life Insurance Company and Equitable Advisors are affiliated and do not provide tax or legal advice, and are not affiliated with Broadridge Investor Communication Solutions, Inc.
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Getting A 401 Loan For A Home
If you’d like to use your 401 to cover your down payment or closing costs, there are two ways to do it: a 401 loan or a withdrawal. It’s important to understand the distinction between the two and the financial implications of each option.
When you take a loan from your 401, it must be repaid with interest. Granted, you’re repaying the loan back to yourself and the interest rate may be low, but it’s not free money. Something else to note about 401 loans is that not all plans permit them. If your plan does, be aware of how much you can borrow. The IRS limits 401 loans to either the greater of $10,000 or 50% of your vested account balance, or $50,000, whichever is less. For example, if your account balance is $50,000, the maximum amount you’d be able to borrow is $25,000, assuming you’re fully vested.
In terms of repayment, a 401 loan must be repaid within five years. Your payments must be made at least quarterly and include both principal and interest. One important caveat to note: loan payments are not treated as contributions to your plan. In fact, your employer may opt to temporarily suspend any new contributions to the plan until the loan has been repaid. That’s significant because 401 contributions lower your taxable income. If you’re not making any new contributions during your loan repayment period, that could push your tax liability higher in the interim.
Those Who Can Pay Themselves Back
Its not free money. You have to pay it back or risk getting hit with a hefty tax bill, says Jeff Levine, of Nerds Eye View, an online news source that caters to financial planners.
Someone who may not be able to pay it back should think a little harder about whether they should tap into their retirement assets or not, Pfau says.
Another thing to keep in mind is how close you are to retirement. For many people, this could force them into an early retirement. Borrowing from their 401 may just be a way of actually starting to take distributions for retirement earlier, Pfau says. You just have to recognize the trade-offs, like not having as much money for retirement down the road.
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Purchase A House Directly Via The Self
A self-directed IRA is usually a personal retirement account with various investment options for you to pick from. An IRA custodian permits this mixture of potential investment options. Employees are not restricted from traditional investments like bonds, stocks, and mutual funds. Instead, a self-directed IRA allows you to access all sorts of funds with alternative investments such as oi, real estate, private intellectual property, and private mortgages.
Self-directed IRA is a precarious house-buying strategy. The IRA is responsible for all costs used in repairing and maintaining the house. For those with insufficient funds in the IRA, you can borrow some funds from the traditional 401k or IRA to boost your self-directed IRA with no tac charges on your income or penalties on early withdrawals. However, you will not benefit from the basic tax advantages as the self-directed IRA does not involve tax paying.
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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Mortgage Interest Tax Strategy
Keep in mind that youll be deducting mortgage interest on your taxes after you purchase your home. This may actually wash with some or all of the income you report from a retirement account withdrawal.
For example, lets say you withdrew $25,000 from your 401k and paid $25,000 in mortgage interest the same year. The $25,000 youll report in additional income will wash with the $25,000 mortgage interest deduction. In other words, your taxable income wont be increased by the withdrawal, and you will effectively pay no tax on it.
However, you will still be liable for the 10% penalty, which is $2,500 in this case. This type of strategy can work for IRA, SIMPLE, and SEP withdrawals as well, but you wont be liable for the 10% penalty unless you withdraw more than $10,000.
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
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Using Your 401 For A Down Payment As A First
Home prices keep rising which means saving the required down payment to buy your first house can be tough.
But as a first-time homebuyer, taking money from your 401 to buy a home is likely not the bestoption.
First-time home buyers are often at a keyage for making retirement contributions. The more cash youput in when youre young, the more time your money has toaccruecompound interest.
For example:
- Say you have $30,000 in your401 at age 30
- After25 years at 7% interest, that $30K will have grown to $162,800
Now imagine youtake out $10,000 to make a down payment on your first home.
- Your 401 now has$20,000 in it at age 30
- After 25 years at 7% interest, itwill have grown to $108,500
- So $10,000 withdrawn now means$54,000 less in your 401 at retirement
This isnt to say a 401 loan orwithdrawal is always the worst option.
But before you turn to yourretirement savings, consider all the other routes available for first-timers to purchase a home.
Can You Use 401k To Buy A Second Home
Good news you can use your 401k to buy a second home. You can, in fact, withdraw from 401k for home and use the amount to purchase a second home or vacation retreat. While you could be hit with a 10% tax penalty, several exceptions are possible for you to sidestep this massive downside. You should note that withdrawals arent state-specific when it comes to penalties, your state income tax may be affected.
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What Happens If You Use Your 401 To Buy A House
Your 401 might be your largest asset, making it a tempting source of funds for your down payment but going this route isnt usually recommended.
Edited byChris JenningsUpdated October 11, 2021
Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”
Saving up for a down payment can be a major hurdle to homeownership, especially since it isnt the only expense in the mortgage process. You might need to come up with money for closing costs, moving costs, and modifications or furnishings for your new home as well.
If youre short on cash, one way you can fund your down payment is to draw from your 401. However, this comes with significant drawbacks.
Heres what you need to know about using your 401 for a home down payment:
Low And No Down Payment Mortgages
Instead of getting a loan for your down payment, you can look into some of the government-backed loans that offer low and no down payment mortgages.
FHA Loans FHA home loans require a low 3.5% down payment, making them a prevalent option. With a down payment this low, you may not need to use your retirement account to afford the down payment.
VA Loans If youre a Veteran, you could qualify for a VA home loan with no down payment. This is one of the greatest benefits offered to Vets in our Country. Not only do VA loans provide 100% financing, but no mortgage insurance is required.
USDA Loans The U.S. Department of Agriculture guarantees USDA loans for low-to-median income families in the countrys rural areas. TDA finances 100% of the purchase price for eligible borrowers.
Conventional 97 Loan This type of conventional loan was created by Fannie Mae to compete with the low down payment government-backed loans. As the name suggests, a conventional 97 loan offers a 3% down payment, allowing you to finance 97% of the purchase price.
Home Possible / HomeReady Loans Fannie Mae and Freddie Mac created the Home Possible and HomeReady loan programs for first-time homebuyers who meet the income limits, have a 620 credit score and a 3% down payment. Your income must be below 100% of the area median income to be eligible.
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Are There Other 401 Options
Withdrawal is not the only way to access 401 funds for a down payment.
Your benefits provider may also offer 401 loan options. If available, this option not only helps you avoid the early withdrawal penalty fee, but also paying income tax on your withdrawal.
401 loans let you borrow up to 50% of your vested account balance Taking out this type of loan puts your 401 account on hold for the duration of the loan you wont be able to make additional contributions until the money is paid back.
But how can you calculate whether the 401 loan is a smart financial decision? As with any lending scenario, the price you pay to borrow the money has a big impact on determining whether the loan is worth it. You can typically expect a 1%-2% spike above the prime rate for these types of loans. Another factor to consider has to do with your employment. If youre unable to pay back the loan on time or before leaving/losing your job, you may be subject to the same financial penalties that come with a withdrawal.
Try Not To Borrow From Your 401k Or Ira To Buy A House
Please dont withdraw from your 401k or IRA to buy a house. Let your pre-tax retirement contributions grow and compound over time. Keep your FOMO for a house at bay. Theres nothing wrong with renting until you can comfortably afford to raise capital specific for your house purchase.
Work on building up the value of your 401k while concurrently building up your real estate capital. If you do, youll be much better off when its time to finally retire. In retirement, you need to count on your 401k, your after-tax investments, and your side hustle to live comfortably.
No longer can you rely on a pension or Social Security. Yes, you will ideally also have a paid off house too. But to do so, you need to buy a house you can actually afford first.
If you cant buy a house following my 30/30/3 rule for home buying, then you cant comfortably afford to buy a house. Use patience and discipline when investing. While you are building your down payment, you can invest in a real estate ETF, a publicly traded REIT, or a private eREIT like the ones offered by Fundrise. The idea is that you want to ride the ups and downs of the real estate market so you dont fall behind.
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How Much House Can You Afford
Generally speaking for conventional mortgage income qualifications, your monthly mortgage payment including principal, interest, property taxes and homeowners insurance shouldnt exceed 28% of your gross monthly income. Governmental loan programs may have higher percentage income qualifications. Youll also need to factor in any remodeling, landscaping or other home improvement projects you want to do both now and later to help determine if a particular house will fit into your longer-term budget.
Dont forget to calculate your other home expenses. Theres the down payment, mortgage payments, insurance, utilities, maintenance and taxes to name a few. Remember to think about how your income might grow over the years. Run the numbers on several different home price points, and calculate your down and mortgage payments to get a feel for what your ideal price range is.
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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