You are buying your dream home – it is both exciting and overwhelming at the same time. With the increasing inflation, home prices, and interest rates sky high, it is challenging not to think, “Is it a good idea to use 401k to buy a house?”
While you might be confused about the decision, we are here to give you all the right answers you need about your 401(k), and you can either tap into it or skip it. We are going to explain the pros and cons, alternatives to you like you were 5. To make an informed decision about your finances and buying your dream home, stay with us till the end.
What is a 401(k)?
What is 401(k) and why is it so beneficial that people keep it as an option while buying a house? Your 401(k) is an employer-sponsored retirement savings plan. 401(k) is tax-deferred, it means that you do not have to pay taxes on your retirement funds until you withdraw them on your retirement.
Normally, the financial advisors do not advise keeping an eye on these savings because they are designed to be there for the long term. Taking money from your retirement or making a withdrawal to buy a house is a huge risk; however, sometimes there is no way out. The high housing costs and strict lending structures coerce aspiring homebuyers to consider their 401(k) funds for their house’s down payment.
Using 401(k) Funds For Buying A House
The good news is that you can use your 401(k) funds to purchase a home as an aspiring home buyer, however, there are conditions attached to it. So, there are two ways you can use your 401(k) funds:
Permanent Removal
In this scenario, if you are under age of 59.5 and you want to withdraw all of your money for a down payment of your house, you will have to pay the early withdrawal penalty of 10% plus tax on the amount.
The advantage of this method is that you get immediate cash to pay as a down payment for your house. The drawback is that you will have taxes, penalties, and growth lost lined up to be paid for.
Loan from Yourself
In this method, you will not have to remove your retirement savings permanently, but take money from your account up to $50,000 or 50% of your retirement balance as funds to buy a home. Then, you will need to pay back the loan in the next 5 years with interest.
The advantage of this particular method is that it allows you to use the funds without taxes or penalties to pay, and the interest you pay will go to your own account. However, if you leave your job at some point in time, the repayment terms might accelerate. In addition to that, if you fail to repay, it will count as a permanent withdrawal, resulting in penalties and income tax on the amount.
401(k) for First-time Home Buyers
As a first time home buyer, if you want to use your 401(k) as a withdrawal for a home purchase, unfortunately, you are indebted to pay income taxes as well as a withdrawal penalty of 10%.
On the other hand, by having Roth IRA or Individual Retirement account, you can enjoy tax perks like no penalty to first-time homebuyers withdrawing funds to use the money for payment on a house. However, you will still have to pay taxes on them.
Pros of Using a 401(k) for Buying a House
Why is it a good idea to use 401k to buy a house? There are certain benefits of using your retirement funds to buy your house. Some are as under:
- Immediate Fund Access: 401(k) is one of the most liquid funds. In the competitive real estate market, timing matters, so it gives a good instant access to cash to buy the house without waiting for long.
- No Impact on Credit Score: As you are borrowing money from your own retirement account, you have no credit checks for loans. In short, your credit score remains unimpacted.
- Low Interest Rates: The interest rates you pay for your 401(k) will be much lower than personal loans or credit cards that impact your credit score.
Cons of Using a 401(k) for Buying a House
With a number of benefits come a number of drawbacks that discourage a lot of first time buyers and repeat buyers use their 401(k) funds for house purchase. Using a 401(k) might not be a good idea because of:
- Taxes and Penalties: When you withdraw from a long-term account, the early withdrawals will hit hard in the form of income tax and withdrawal penalties.
- Retirement Risk: When you take your funds out of your long-term retirement plan, you lose the compound growth you were getting. And believe me, it will cost you more than you think.
- Employment Risk: Under any circumstance, if you leave your job, you will not be able to pay your loan immediately or on time.
- Double Tax: First you repay the loan with after-tax dollars and then again payable tax on the withdrawal at the time of your retirement.
Should I Pay For my House Using 401(k)?
Well, if you have other options to purchase a second home or a primary residence, consider them first. Using your 401(k) funds to buy a house isn’t a good idea, but it comes with a cost.
You should go for it to fund a home purchase, if:
- You have already gone through all of the other options.
- You have found the house of your dreams and can’t waste time in the competitive market.
- You have no other source of funding.
- You are confident that you have job stability.
You should avoid it to buy a new home, if:
- You are under 60 and can’t afford penalties.
- You have other lending or program options that can get you mortgage assistance.
- Your risk of derailing your long-term financial security is higher.
However, experts advise to avoid using 401(k) or keep it as the last resort. If you want to take out funds for a home purchase from your 401(k), at least use it with caution and talk to your expert advisor or Realtor like Nitin Kumar to avoid any future mishaps.
Alternatives to 401(k)
There are a number of programs and home loans that provide you down payment assistance if you want to make a home purchase. However, you must also know the common mistakes people make while signing up for a mortgage loans. Some of the assistance programs include:
First-Time Home Buyer Assistance Program
Especially in Texas, MFTH (My First Texas Home) and MCC (Mortgage Credit Certificate Texas) have introduced city-specific programs in Austin, Dallas, and Houston Texas with a ton of benefits that lower your down payment and closing costs.
IRA Withdrawal
Home buyers having Roth IRA for more than 5 years can withdraw money up to $10,000 in contributions without any penalty or tax. These are way ideal than 401(k) for down payments.
Gifts from Family Members
You can use gifts from your family members to pay the down payment to buy a home. Many lenders do accept it however, you must document it properly to avoid any confusions or problems in the future.
Saving
Saving for a down payment is your best friend if you need to buy a house. Just save up money the good old-fashioned way by opening a high-yield savings account dedicated to your down payment only. It does take time but it will help you avoid certain taxes and preserve your retirement funds.
Conclusion
So, is it a good idea to use 401k to buy a house? You need to understand this fact that your 401(k) fund is your retirement fund, not an account to buy a house of your dreams. If you want to purchase a primary residence or buy a second house at some point of time in the future, try saving for it beforehand, use mortgage payment assistance or down payment assistance programs and forget about your 401(k) until you are retired.
Nevertheless, if you don’t have any other option, it is possible to use funds 401(k) – with the right strategy, solid income, strong credit, and repayment plan. One of the smartest moves is to contact a professional Realtor who already have helped many first time buyers and repeat buyers in Austin or other cities in Texas to smartly purchase a home they cherish for a lifetime.
Frequently Asked Questions
Q: How much can you take out of your 401(k) to buy a house without penalty?
A: You can withdraw the money from your 401(k) account without penalty if you are 59 or older. Otherwise, it is nearly impossible to use the funds without financial implications.
Q: Is it a good idea to use your 401(k) to pay off your mortgage?
A: In most cases, no! It might seem very appealing to pay off your mortgage with your retirement fund however, it is going to leave you in a huge long-term loss, taxes, and penalties.
Q: How do I avoid 20% tax on my 401(k) withdrawal?
A: Usually, it is impossible to avoid tax on your 401(k) early withdrawals but waiting till retirement will help you avoid 20% taxes.
Q: At what age is 401(k) withdrawal tax-free?
A: After the age of 59, you can withdraw your 401(k) without any penalty but you will have to pay income tax. However, Roth IRA is exempt of any tax.
