Can I use my 401k to buy a house?
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September 25, 2022

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Knowing how much you can afford to spend on a home is only half the battle. 

The other half is coming up with the funds to cover the down payment and any closing costs. 

If you’ve been asking yourself, “Can I use my 401k to buy a house?” you’ve come to the right article. 

In this post, we’ll look at ways you can use funds from your 401k toward a house, whether using a 401k for a down payment as a first-time home buyer might be a good idea, the CARES Apct, and a 401k withdrawal for a home purchase. Let’s get started.

How much do I need to buy a home?

Closing costs can start from zero-down, as with VA loans, and while there really isn’t an upper limit, the maximum down payment for many conventional is 20% of the home’s purchase price. 

Add to that closing costs, such as legal and real estate fees, in addition to other costs to finalize your home loan. These costs usually range between 2% to 7% of the purchase price. 

The median price of a home in the US is currently $428,000. Even if you put 5% down and paid 3% in closing costs, you’d need to come up with just over $34,000 to purchase your new home in this example.  

A mortgage calculator can help you estimate how much money you might need and how your down payment amount can impact monthly mortgage payments. 

 How does withdrawing from a 401k work?

There are two ways to use the funds from your 401kto buy a house: 401k loan and 401k withdrawal.

401k loan

With a 401k loan, you are required to repay the funds plus interest. 

It’s important to note that not all plans permit members to borrow from their 401k, so check with your plan to see their rules. 

Borrowers have five years to repay their 401k loans—loan payments don’t count as contributions to your 401k, and some plans halt new contributions until loan amounts are repaid in full.

What happens if I leave my job?

If you leave your job, are laid off, or are fired before you’ve repaid the loan, the entire balance becomes due at tax time. 

If you cannot repay the loan at tax time, the 401k loan gets reclassified as an early distribution of retirement funds. It is generally subject to income taxes plus a 10 percent early-withdrawal penalty for those under 59½.

How much can I borrow from my 401k?

The IRS allows you to borrow up to a maximum of $50,000 or half of your vested account balance, whichever is less. 

If you have a 401k with a vested balance of $75,000, you would be allowed to borrow $37,500 for the purpose of buying a house.

Does my vested balance drop if I take a 401kloan?

Using funds from your retirement accounts can significantly negatively affect long-term retirement goals. By withdrawing funds early, you don’t get the benefit of compound interest. And you may not have enough time to recoup those losses when you repay the funds. 

When you take money out of your 401k, your balance will drop temporarily but rise again as you repay the loan.

401k loan: tax considerations

Contributions to your 401k are ‘pretax,’ i.e. before you pay tax on it. 

Payments on a 401k loan are made with ‘after-tax’ dollars, and taxes are withheld from your initial loan amount. So essentially, borrowers pay double taxes on their loan amount. As a result, many financial advisors recommend limiting borrowing from a 401k to emergencies only. 

Debt-to-income ratio (DTI) 

Your 401k monthly loan repayment amount will be included in your overall DTI. Most mortgage lenders set a maximum DTI of 45% when assessing how much of your gross income is spent on debt repayment. 

The CARES Act: 401k Withdrawal For Home Purchase (2022)

The Coronavirus Aid, Relief, and Economic Security Act, otherwise known as the CARES Act, was a stimulus bill passed in March 2020 to lessen the financial impact of the coronavirus pandemic. 

The CARES Act relaxed numerous rules dealing with retirement plan loans and outright withdrawals. The CARES Act increased the 401k loan limits to the lesser of $100,000 or the vested account balance. 

The Consolidated Appropriations Act 2021 extended this temporary loan limit increase through mid-2021.

401k withdrawal

Unlike a 401k loan, the money you withdraw from your 401k doesn’t need to be repaid, and there’s no limit to the amount you can withdraw. 

The major hurdle to a 401k withdrawal is that qualifying for withdrawal can be challenging. Not all plans allow withdrawals, and many plans that do allow withdrawals require proof of hardship before authorizing a withdrawal. 

Withdrawals must meet the IRS requirements for “hardship distribution,” that the applicant or their spouse must be experiencing an “immediate and heavy financial need.”

401k withdrawal: tax considerations

If your plan does allow for a 401k withdrawal, there are tax considerations to keep in mind. 

Depending on your age, you could face a 10% early withdrawal penalty in addition to regular income tax. 401k plan custodians typically withhold 20% of 401k withdrawals for tax purposes.  

If you withdraw $50,000 from your plan, your plan custodian will withhold $10,000 for taxes, and you might also lose another $5,000 to the early withdrawal penalty (10%). 

What if I’ve purchased a home before?

Eligible first-time home buyers and seasoned homebuyers can use the funds in their 401k to buy a house.

Non-401k options

It’s worth considering other down payment options before reaching into your retirement savings, such as down payment assistance programs and financial gifts from family or friends. 

Additionally, some loan programs, like FHA loans, offer more lenient credit requirements and down payments as low as 3.5%, making them popular among first-time homebuyers. FHA loans also allow financial gifts toward the down payment of a home.

If you’re a veteran, active servicemember, or surviving spouse, you may be eligible for a zero-down payment home loan.

While tapping into the money in your 401k can offer some benefits, it can also impact your long-term financial goals and should be carefully considered before taking action. 

AAA Banking can give you options

At AAA Banking, we want to help you make the best financial decisions for today and tomorrow. 

Reach out to our licensed loan officers today, and let’s discuss your situation. 

Together, we’ll help you decide the best course of action to help you make your dream home a reality.

Image by kstudio on Freepik

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