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How to Use a 401(k) for a Home Loan

by Christopher Raines

Your 401(k) is a nest egg for your retirement years, composed of a portion of your pretax earnings and perhaps an employer match or partial match of your contributions. You pay taxes only when you withdraw money. The 401(k) also serves as a pool from which you may draw to become a homeowner. Depending on your age and circumstances, you may avoid paying certain penalties for prematurely taking money out of your 401(k). However, you need to carefully consider your retirement needs, present financial condition and other ways you can buy a home without disturbing your 401(k).

If you are 59 1/2 years old or older, then you are eligible to withdraw funds from your 401(k) account without any stipulations. You will have to pay normal taxes on any amount withdrawn, however. If this is your situation, you can withdraw a lump sum for a down payment on a home or even request monthly distributions which can then be used to make your monthly mortgage payment.

Apply to your 401(k) plan administrator for a loan from the plan, if the plan documents permit such. Complete and return the forms, if any, provided by the administrator. Borrow up to the amount of the down payment. Generally plans have a maximum loan amount. Under federal law, no more than the smaller of $50,000 or half of your 401(k)’s vested value; for example, you can borrow up to $30,000 if your 401(k) is worth $60,000. Choose a repayment period, which for a home loan is allowed to exceed five years.

Ask the plan administrator for a hardship distribution if you have exhausted all of your available 401(k) money, and if it is permissible under the plan. Explain that you cannot pay the costs of buying the home with insurance or selling other property. You probably cannot show a need if you are holding on to a vacation home, even if it has both you and your spouse’s name on it. Hardship distributions are subject to regular taxes and a tax penalty if you are under 59 1/2 years old; they are not loans so they are not paid back.

Tips

  • If you take from your 401(k) at age 59 1/2 or later, you will pay ordinary income taxes, but not an additional 10 percent early withdrawal penalty.
  • Ask your lender if you can make a down payment with money from your 401(k). FHA lets you draw up to 60 percent of your 401(k)’s value for the down payment.
  • The hardship withdrawal is limited to the difference between what your employer has put into the 401(k) and any other hardship withdrawals you have taken.

Warnings

  • Taking out a 401(k) loan increases your debt and may cause you to pay higher interest rates or even disqualify you for a home loan.
  • The withdrawal from a 401(k) loan is taxed if you fail to repay or return the money to your plan. If you lose or change employment, you must pay back the entire remaining loan balance or pay income taxes on the unpaid balance.
  • You cannot deduct interest for a 401(k) loan from income taxes, even if you use the money to buy a home.

About the Author

Christopher Raines enjoys sharing his knowledge of business, financial matters and the law. He earned his business administration and law degrees from the University of North Carolina at Chapel Hill. As a lawyer since August 1996, Raines has handled cases involving business, consumer and other areas of the law.

Photo Credits

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