Once you turn 59 ½, you’ll become eligible for penalty-free withdrawals from your 401(k). You can also qualify if you retire at 55 or decide to apply for a hardship withdrawal.
Should you use a 401(k) to buy a house? While penalty-free withdrawals can be a lifeline in a hardship situation, it’s rarely a good idea to use a 401(k) withdrawal to put a down payment on a home.
What happens if you use a 401(k) to buy a house?
Buying a home with a 401(k) withdrawal means moving assets from your retirement account to the equity you own in your new home. It lowers your 401(k) balance, and the amount you withdrew won’t be collecting compound interest until you repay the loan. Depending on the amount of your 401k withdrawal, you could be significantly reducing your future distributions, which can result in financial hardships in the future.
Even though a home is a smart investment, it’s not an asset where cash is easily available unless you decide to sell your property. Plus, you’re lowering the growth potential for the assets you’re transferring from your retirement account to your home equity. On average, you can expect your home to appreciate at a rate of 3.5 to 3.8% a year, while a 401(k) has a return rate of as high as 10% with the right investment strategies in place.
Does a 401(k) loan make sense?
You can use a 401(k) to buy a house by borrowing against your retirement account instead of taking an early distribution. However, this financial move has some major drawbacks.
The IRS rule states that you have five years to repay the loan and must make quarterly payments. It’s a relatively short period of time.
Taking money out of your 401(k), even temporarily, can hurt your finances in retirement:
- The money you borrow will not grow compound interest while it’s out of your 401(k).
- You’ll have to repay the loan before contributing to your 401(k) again. It can put you behind on your retirement goals.
- You’ll pay the loan back with interest. The money you spend on interest could have been invested in your 401(k) instead.
You should also know that you’ll have to repay the totality of the loan by the end of the year’s tax filing date if you change jobs. Otherwise, the IRS will consider your loan as an early withdrawal, and you will pay a 10% tax penalty.
Alternatives to using a retirement fund to buy a home
It’s best to leave your retirement savings intact and let these assets grow so you can retire comfortably. There are financially sound alternatives to explore on your path to homeownership.
First of all, you might not need as much as you think for your down payment. More than a third of people believe that the average down payment is somewhere between 16 and 20% of a home’s value. In reality, homeowners typically put 7 to 17% down.
For current homeowners, the sale of their current property is the best way to generate the cash flow you need for your down payment.
For first-time buyers, consider a low downpayment loan option. In some programs you can put as little as 3% down depending on your credit score.
There are other programs to consider:
- You can qualify for an FHA loan with a 5% down payment if you have a credit score of 580 or higher. You can qualify for a loan with a 10% down payment if your credit score is somewhere between 500 and 579.
- If you’re a veteran or on active duty, you can apply for a VA loan with no down payment.
- Some properties in eligible rural areas qualify for a USDA loan with no down payment.
Conclusion: Should you use a 401(k) to buy a house?
Withdrawing or borrowing from your retirement savings is rarely a good idea. Instead, you should look into mortgage programs with low or no down payments.
First, Centennial Mortgage can help you find the best mortgage product based on your finances and homeownership goals. Get in touch with us, and one of our mortgage loan officers will discuss your options.