Is Using Your 401K For Down Payment A Good Idea?

Your employer based 401K retirement plan may have an option for you to take out a loan against all, or a certain portion, of the account for “hardship” reasons.  Using your 401K for down payment on a home is considered a “hardship” reason.

What is a 401K Loan?

A 401K loan is money that may be available to you based on certain conditions of your 401K retirement plan offered by your employer.  The interest rate charged is typically lower than if you borrowed money from a bank.  Since it is secured money. That means the collateral for the loan is your 401K. Your mortgage lender will allow it to be used for down payment requirements on a new home purchase. (see video below for further discussion on “secured” loans)

Is it a good idea?  The answer is it depends.  The first step is to discuss the terms with the administrator of your 401K plan.  Below are a few pros and cons, but keep in mind that terms of various plans can vary.  Discuss the items below with your administrator to see how, or if, they would affect you.

Pros

  • The principal AND the interest you pay goes back into your account.  In essence, you are paying yourself.
  • No need to “qualify” for the loan.  It most cases it’s a simple phone call to your plan administrator.
  • It’s not a debt that is reported to the credit bureaus.
  • In most cases, the payment is not considered by the lender when they calculate your qualification for the new mortgage.
  • You can always pay the loan back sooner than required.  You could increase your monthly payment; add extra money when you can or even pay it off in one lump sum.

Cons

  • While your 401K loan is outstanding, you may not be able to make full contributions to your retirement plan.
  • If your employer is one that “matches” your contributions; you may also lose out on that benefit.
  • If you quit or lose your job; you may have as little as 60 days to repay the 401K loan. If you don’t repay the loan; it will be considerred a distribution.  Early withdrawals of retirement funds (distributions) come with penalties and are taxed as income in that particular year.  Quite often you can roll your existing retirement account from one employer’s plan to another; but typically NOT the loan.
  • You will not be earning money in the market on the amount you borrowed.  If if’s a strong economic time you will lose out.  Of course, if the it is a weak economic time, you won’t be as harmed as much by lack of earnings.

Alternatives and Options

There are many loan programs that you may qualify for with as little as zero to 1% down payment.  You’d have to sit down with your loan officer and pencil it out.  Would your available 401K loan funds result in a substantially lower mortgage payment?  It could make the difference in reducing your mortgage insurance expense?  Would it reduce it enough to offset the risks mentioned above?

You could borrow funds for your down payment from another source as long as you secure that loan with an asset. For example, if you own a car with enough equity; you may be able to refinace the car with your bank.  Keep in mind that the payment on the new car loan will figure into your qualifcation for the mortgage.

You could sell a vehicle for cash.  Talk to your lender BEFORE you do this.  They may ask you to produce documents to show (1) you owned the vehicle (2) the fair market value of the vehicle and (3) the proceeds you received from selling it. It is always much easier to gather documents during the transaction then have to go back and recreate them.

Selling any asset can get tricky as it easily turns into a paper nightmare.  Unless you are doing it at least 3 months before you see a lender; talk to the lender before the sale.  It can be difficult to document a value of a personal asset.  At times it is also pretty tough to document your ownership.  Trust me – a selfie of the item in your hand will not work!

Here’s a video I recently produced to give you all the details about how to use something you already own to obtain down payment money.

Don’t forget the option of a family gift.  Perhaps that rich uncle (or aunt!) of yours is ready with his checkbook?  Most loan programs allow for a family member to gift you a down payment with little to no funds from you.

Conclusion

It’s not an easy answer to give you.  Borrowing from your 401K fund is usually easy and simple, but it does carry some risks.  Make sure you do your research on your particular 401K plan; understand the risks and be comfortable you can live with those risks.

What do you think?  I’d be interested to hear from you if you’ve had a bad experience with a 401K loan.  So many buyers use this resource; it’s be helpful to hear real life stories of the outcome.  Please share your comments (and questions) below.

 

 

 

 

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6 Responses to Is Using Your 401K For Down Payment A Good Idea?

  1. Barry says:

    Great article Leissa! I think it’s good to show all the options that are available for people to make an informed decision.

    I am against using 401k loans unless absolutely necessary for many of the reasons you outlined in the cons section. I know home buying is a very emotional subject with many but I think it would be best to save up the down payment while renting.

    When I was younger, I did make the decision to use a 401k loan which bit me when I left the company and still had more outstanding than I could repay when it was called. The taxes and fees hit pretty hard. Lesson learned.

    • Leissa Gebert says:

      Thank you, Barry, for your comments.  I especially appreciate your story how using a 401K loan was ultimately not your best option.  When I was working as a loan officer; there were a few clients that were adamant about using their 401K.  I never heard from them after as to whether it was easily repaid or turned into the heavy cost that you had to ultimately pay.

      I am a bit “old school” as well and believe that if you save for something; it has more meaning when you get it… more reward.  Saving also helps you to adjust your budget for what may be a higher housing payment after you buy.  This is one of my main goals in reaching first time buyers BEFORE they see a lender and get sucked into the emotional journey and may not make the best decisions.

  2. Tony Spagnolia says:

    I have to say I am completely against the 401k as a down payment. The 1 percent loan scheme is also not a good idea since you will have to pay private mortgage insurance on the loan until you get to 20 percent equity. I suggest waiting until you can afford 20% and buying something under what you can afford since you never know what life will throw at you.

    -Tony

    • Leissa Gebert says:

      I hear you, Tony. Under most circumstances, I also am not a fan of the 401K loan. As far as the 20% down payment; unfortunately that is out of reach for most first time buyers unless they have family with deep pockets to gift. Just this morning I came across a new study compiled by Keeping Current Matters; a research firm I frequently use for data. Here’s a great info graphic; which shows the amount of time it would take to save up just 10%; depending on where you currently live in the country. 2.5 years in Iowa is feasible; but 21 years in Oregon or California? Yikes!

      Mortgage insurance is no fun to pay; I agree, however, it can be removed once you have that 20% equity position in the home. That can be accomplished by accelerating the principal payments on your mortgage combined with a possible appreciation of your home’s value.

      Depending on what part of the country you live in; just getting your “foot in the door” to homeownership can be a challenge. During my career I helped many folks with small down payments on their first home and witnessed them being able to parlay the equity they earned into their next home, etc. I am in the Pacific Northwest area where rents are close to being more than a mortgage payment right now. Something to think about.

      I’m totally on board with you about affordability and planning for those unexpected life events. A responsible lender or loan officer is going to help counsel that first time buyer. Depending on their circumstances; a small down payment might just be a good option for them – or not. As with anything financial; it’s always about your personal financial situation and getting the right information in front of you to make a good informed decision.

  3. Rebecca says:

    I agree with everything you said. If there are other resources available, it is better to use those instead. It is best to just leave the 401k alone in peace and leave it to grow until ready for distribution. There are so many pre-approved loan offers or pre-approved credit card offers with 0 interest for 18 months. I think those are good too instead of the 401k. I guess, we just have to evaluate our options very carefully.

    • Leissa Gebert says:

      Thanks for the comments, Rebecca.  As someone on the other end of the “age” spectrum; I can sure attest to the value of leaving your 401K alone, when at all possible.  It can seem when you are in your 20’s and 30’s that you have all the time in the world to save for retirement.  It is an unfortunate illusion mamy fall prey to.

      You do, however, have to be careful about those pre-approved credit offers.  First of all; if you borrow money for a down payment and it’s not secured by an “acceptable” asset you already own, there is a good chance your lender will not allow it as down payment money.  Here’s a video I just published on my YouTube channel about that very thing!  

      Those pre-approved credit offers are generally nothing more than a creditor’s enticement to get you to officially apply for a loan.  That could mess up your credit score a bit if it’s a revolving loan (like a credit card) and the terms are never guaranteed until they approve you.  (the fine print – right?)  The interest free offers can be risky unless you are certain you can payoff that loan during the interest free period.  The interest rate that kicks in on those after the interest free period can be in excess of 25%. Yikes!

      I do appreciate your valuable input.  Down payment issues are an on-going discussion; to be sure.  🙂

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