With most home loans, you will be required to place a down payment in order to secure the mortgage; sometimes the down payment amount can be significant. Many borrowers will run into the issue of not having enough in savings to cover the required down payment amount, therefore they will begin looking into other options in order to finance the requirement.
One way home buyers will seek to fulfill down payment obligations will be to withdraw the necessary funding from their 401k or IRA accounts. But, is this a good idea? Below, we’ll visit using your 401k or IRA for a down payment on a home and if it’s the right decision for you.
How much can you borrow from your 401k or IRA and how is it repaid?
401k’s and IRA’s have certain tax advantages, however, when you draw early on them before retirement, you can be assessed a 10% tax penalty. This penalty can be avoided if you repay the amount you withdrew within a timely manner, but you’ll typically need to set up automatic withdrawals from your paychecks as soon as possible to ensure this happens; 10% is a pretty steep penalty on your retirement funds that you will want to avoid.
There are limitations on IRA’s and 401k’s as to how much you can borrow; these limitations are st at no more than $50,000, or no more than 50% of your account balance, whichever is higher. Also, if you have less than $10,000 in your account, you are able to borrow the full $10,000 amount.
Should you borrow from your 401K or IRA account?
Making the decision as to whether or not you should borrow from your retirement accounts in order to fund your housing down payment can be a tricky decision. There are many financial advisors who would advise against borrowing against your retirement, however, it can be beneficial in some situations. Consider the following when making your decision:
- Will you be able to repay the balance you borrow in order to avoid the IRS tax penalty?
- How quickly will you be able to repay the amount you borrowed? Typically, being able to repay the loan within a year is preferred.
- Will the amount you are considering borrowing reduce your mortgage amount a substantial amount and save you in monthly mortgage costs and/or reduce how long your home will be financed for?
- Will the amount you are borrowing from your 401k or IRA potentially get you a better mortgage rate offer with a substantial down payment?
There are also potential downfalls to borrowing early from your 401k or IRA. It’s important to weigh your decision against these possible risks to decide if this is the right step for you to take. Some problems you may incur are:
- The risk of facing penalties if you leave your company and have not repaid the borrowed money back into the company 401k.
- Some companies do not allow further contributions to a 401k until a loan is repaid. Furthermore, the company may halt any contribution matching, thus causing you to lose out on money.
- While placing a substantial down payment on a home may reduce your overall mortgage expenses, you may be temporarily paying more out of pocket in order to repay your 401k or IRA back in time before incurring penalties. You’ll need to decide if this is something you’ll be able to afford.
- You can find yourself in a situation of being “double taxed” as your interest payments will be taxed when being paid into your 401k. Once you begin withdrawing from your 401k in retirement, you will be taxed again.
Consider speaking with your mortgage lender before making this decision so they can help you weigh the pros and cons. Your mortgage lender may also be able to suggest some helpful alternatives to withdrawing against your IRA or 401k accounts.