Want to take advantage of the low-interest rate climate but your credit score is damaged and traditional lenders won’t approve your loan applications? There could be another financing alternative. One you might never have considered: 401k.
Yes, you could tap into your 401kand use it to fund the down payment of a new home. What’s more, your payments, interest included, goes right back to your 401k fund.
So how do you take advantage of this option? This articleexplains the top reasons why you should consider a 401k loan for a home down payment. But what are the risks of taking out a 401k loan for the purpose of purchasing a home? Let’s look at the details.
Revamps Loan Repayment Terms
The typical repayment period of a 401k plan loan is five years. Anything not repaid within this period will be considered as a distribution. But if you take out a 401k plan loan to buy a home, it will no longer be subject to the said condition. The property, however, should be your primary residence to qualify.
Is there a limit to how much I can borrow?
You can only borrow up to 50 percent of your vested account balance. This applies for all your 401k plan loans together. Therefore, if you are already borrowing the maximum allowable limit, you cannot borrow more from the fund.
What happens when I fail to pay?
There will be fees associated with a failure of payment. Usually, your employers just directly deduct money from your paycheck for repayment. But if you fail to pay, the IRS will take it as a distribution with an amount equal to the loan’s outstanding balance. That means if you owe $30,000, you will have to include this same amount as a taxable 401k plan distribution. On top of that, you are at the risk of paying a 10 percent of the amount as penalty on early distribution if you are not yet at least 59 years old and a half.
When circumstances make early repayment necessary
You need to come up with loan repayment immediately when you leave your job, else your remaining payable loan will be subject to the penalties stated previously. That is, if you still owe $20,000 on your loan, that amount will be considered as distribution for tax reasons and you will have to pay the penalty for being not of the qualifying age (at least 59 1/2 years old).
Your 401k could be your saving grace when push comes to shove and you can’t delay your purchase for later. If using the money for a down payment could also save you from paying a private mortgage insurance, however, you might end up saving the most money in the end, especially taking into account that the interest you pay on the loan goes back to your retirement fund anyway.
If you are hesitant about taking out a 401k, talk to an expert and receive updated guidance on market conditions and novel financing options.