If you want to buy a house, you will need a down payment. If a lack of savings is the only thing holding you back, you may be able to tap into your 401K to get the funds you need.
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Before you go and take out the funds you’ve saved up for your golden years, use the below tips to help you make it a profitable situation.
Borrow From Your 401K
We strongly suggest that you don’t withdraw funds from your 401K. Withdrawing funds before you are of retirement age can leave you with a large tax liability plus a 10% penalty. That down payment on your home could suddenly get really expensive.
Instead, we suggest that you borrow from your 401K. In essence, you give yourself a loan. You will pay interest on the loan, but you’ll pay the interest to yourself, not a lender. You may be eligible to borrow the lesser of $50,000 or half of your 401K balance. If you borrow the funds, you won’t pay taxes or penalties for early withdrawal.
The Details of the 401K Loan
Before you take out a 401K loan, you should know how it works. Of course, you should check with your plan sponsor as each plan operates differently, but the following guidelines are fairly standard:
- You will likely pay interest of at least 2 points over the current prime rate. This will help make up for the interest you lose by taking your funds out of your 401K early.
- You will only have a specific period to pay the funds back. Many plans require you to make quarterly payments for five years. You’ll need to know the specifics from your plan sponsor so that you can make sure you can afford the payments.
- If you leave your company, the loan may become due and payable immediately or at least within 2 to 3 months. If you don’t pay it back, the plan sponsor can consider it a hardship withdrawal, which will end up costing you taxes and interest.
- You cannot make contributions to your 401K while you have an outstanding loan. This means that your 401K’s potential decreases because you can’t contribute to it.
Other Ways to Get Money for a Down Payment
The good news is that your 401K isn’t the only way to get money for a down payment. In fact, you may not even need as large of a down payment as you think. Many people assume they still need a 20% down payment. That’s not the case today. There are many programs that you can utilize that require little to no money down on a home.
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A few examples include:
- VA loan – If you are a veteran that served at least 181 days during peacetime, you may be eligible for a VA loan with no down payment. The VA allows 100% financing on loans as much as $453,100. That means you can buy a home for as much as $453,100 and leave your 401K alone.
- FHA loan – The FHA loan is for anyone that qualifies. You need just a 580 credit score and a 31/43 debt ratio to qualify. You will need a 3.5% down payment for this loan, but 100% of the down payment can be a gift from a qualified donor, such as a family member or employer.
- USDA loan – If you don’t mind living in a rural area and your household income doesn’t exceed 115% of the average income for the area, the USDA loan may help. This loan also provides 100% financing for low to moderate-income families.
Even conventional loans can be done with just 5% down on the home. As you can see, you don’t necessarily need a 20% down payment. If you are creative, you may be able to leave your 401K alone and let your retirement funds grow.
If you have to use your 401K funds, take a loan and make sure you can pay it back quickly. Only choose this option if you know you are stable in your job and aren’t about to change jobs. Keep in mind that you lose any employer contributions or the ability to grow your 401K until you pay the loan back in full.
