Using Your 401K as a Down Payment

Using your 401K as a down payment is an option when buying a home. Saving for a down payment is very difficult for many would-be home buyers. With the need to try to find 20 percent of the purchase price to get lower interest rates, and avoid mortgage insurance, it can be a struggle. Using your 401K as a downpayment can be another expense of homeownership.

If you have saved for your retirement, however, you could be using 401K as a down payment when home buying. This may be a very viable option to be using your 401K as a downpayment. Let’s look at the options.

Your 401K Vested Balance

The vested balance is the amount of money that you could take from the plan if you were to withdraw from it now. If you have contributions from your employer, those contributions aren’t always available to you, but the money you put into your plan is.

Each year, some of the money contributed by your employer becomes available to you. This will eventually lead to you becoming fully vested, perhaps after being with the company for 5 years, when you can take the full amount in the 401K.

You will have to check the terms of your plan with your employer to work out when you will be fully vested, as different employers set different vesting periods.

Hardship Withdrawals from Your 401K

You will have different options depending on your situation. If you are a first-time buyer, you can take a hardship withdrawal of up to $10,000 per person.

This doesn’t normally allow you to avoid the 10% withdrawal penalty if you are under the age of 59 and a half, however, and is only available for people that haven’t had any ownership of a home in the last three years.

There is the requirement to pay income tax on the amount withdrawn, and the tax can be paid at the time of withdrawal or when filing your taxes.

To be able to do this, you need to prove to the plan administrator that you don’t have other means of getting the down payment money for your home.

Taking a Loan from Your 401K

You could also take a loan from your 401K. You are allowed to take a loan of either up to $50,000 or 50% of the vested balance.

The terms of this arrangement depending on your employer. This means that the loan period is up to them, typically it is 5 years though.

There will also be rules regarding repayment of the loan should you quit your employment or get fired. Leaving your job will be considered to be a withdrawal from the plan, and you will have to pay a penalty of 10% as well as income tax also being due. If you find yourself in this situation, you only have 60 days to repay the loan to avoid the penalty, which could be particularly difficult if you’ve just been fired.

The rate of repayment needs to be known as well. Though you are paying the money back to your plan rather than a lender or the employer.

Hardship Withdrawal

If you need to find more than with either of the previous methods, you can combine the two. You may be required to take a loan before any hardship withdrawal will be allowed.

When utilizing the funds to purchase a home, you are making a hardship withdrawal. Whether buying a new home counts as hardship can be questionable. Generally speaking, the IRS will allow it if the money is urgently needed for a down payment on a principal residence.

There are tax implications, however. It is likely that you will incur a 10% penalty on the amount you withdraw unless you meet the criteria rules for an exemption on the money utilized. You will still owe income taxes on the amount of the withdrawal from your 401K.

You’re only limited to the amount necessary to satisfy your financial need, and the withdrawn money does not have to be repaid.

Borrowing from your 401k could affect your ability to qualify for a mortgage. Although you owe money to yourself, it still will count as debt to a lender. Your loan will be a contingency of purchase when buying a home. And another contingency that you will have is an appraisal of the home unless you waive it.

Things to Consider

Using your 401K as a down payment when home buying can seem like a good idea. It allows you to potentially avoid having to pay private mortgage insurance and gives you a better interest rate, but there are some negatives as well.

You need to take into consideration all of the expenses involved with home buying, and the long-term effects on your retirement fund. Your retirement savings will be less than they would have otherwise been. If you do the calculations, you might discover that it will work out better to provide a smaller down payment and pay mortgage insurance.

If you take a loan, you will have a relatively short period of time to pay it back, on top of your mortgage payments. You could also miss out on your employer’s contributions during this payment period. Then there are the risks of losing your job within the repayment window, meaning that you have 60 days to repay the amount outstanding on the loan to avoid the 10% penalty.

Taking from your IRA or 401K as a down payment should only be a last resort. Before you make the decision, you should consult a CPA to make sure you are doing the right thing, and you understand the implications of your financial future.

How Long it Takes to Obtain Funds from Your 401K

Be sure to check at the institution how long it takes to get your funds out if you plan on using your 401K as a downpayment. It can generally take up to 5 days to get the dispersed, so it is important to plan ahead if you are getting a loan and need to have the money wired into escrow. You should have other funds saved for your earnest money deposit as that is required to be deposited within 3 days of an executed contract.

When making an offer on a home, you will need to demonstrate to the seller that you have the funds for the downpayment and closing costs. The balance of the downpayment will have to be wired into escrow before closing. There are many real estate questions during the home buying process.

Final Thoughts

It is important to evaluate your financial position when home buying. You need to make sure you have funds for the down payment and closing costs. It is always a good idea to save for a “rainy” day. You don’t want to deplete all your funds. It is good financial advice to keep some money in the event your home needs some maintenance or repairs. Even though you will likely be getting a home warranty with the purchase, planning ahead is always wise. If you are going to be using your 401k as a down payment, then discuss this option with your financial planner to ensure it is the correct option.

About the Author

The above real estate article “Using Your 401K as a Down Payment | 5 Important Facts to Know” was written by Sharon Paxson of Newport Beach Real Estate. With experience since 2005 representing sellers, buyers, and landlords with their real estate transactions, we welcome the opportunity to share our knowledge and expertise and guide you through the home buying or selling process.

We service the following Orange County CA areas: Corona del Mar, Huntington Beach, Laguna Beach, Newport Beach, Newport Coast, Orange, Sunset Beach, Tustin, and more! If you are considering selling your home, we welcome the opportunity to work with you and list your home with a top Newport Beach CA Realtor.