Can I use my 401k to buy a house in 2010?
By Brandon Cornett | © 2013 All rights reserved
Question: "I want to use money from my 401k account to make a down payment on a home next year. Can I use my 401k to buy a house, and are there any pros and cons I should know about?"
It's disheartening how often we receive this question from readers. Apparently, a lot of people out there are thinking about tapping their retirement savings for down-payment funds. It's a sign of the times, I guess. But I digress.
Let me start with the short answer. Yes, it's possible to use your 401k to buy a house (in this case for down-payment purposes). But you might have to pay taxes and penalties on the early withdrawal. So you need to weigh the pros and cons. You also need to find out exactly how much you might pay in penalties. This is something I can't help you with, as it varies from one account to the next. Read the fine print in your 401k paperwork.
You can withdraw funds from your 401k account to cover the cost of a down payment. After all, it's your money. But these accounts are designed to encourage long-term savings, and to discourage you from making early withdraws. So you will most likely pay a penalty by withdrawing money from your 401k early -- to buy a house, or for any other purpose.
The IRS allows "hardship withdrawals" in certain scenarios. If you're using the money to cover the down payment on a house that will be your primary residence, it may qualify as a hardship. But you still might have to pay income taxes and even a penalty fee on this kind of withdrawal. You need to review the IRS rules for this particular situation, before you move forward.
Alternatives to Using Your 401k
You should also look into other sources of down payment funding, and compare the cost of those options to the cost of using your 401k funds. You might be able to get a second mortgage on top of the first, to minimize the amount you have to put down. Or the lender could finance more than 80% of the home value and have you pay private mortgage insurance or PMI (which is required on home loans that exceed 80% of the value).
You'll have to look into all of these options for making a down payment, taking the early withdrawal fees into account. Which strategy would cost you more, in the long run? What are the tax implications for each method? If you conduct this kind of research and find that the withdrawal option will cost less, then using your 401k to buy a house might be your best option.
Does It Make Sense to Buy a House Right Now?
Here's another important consideration. When you use some or all of your 401k to buy a house, you are basically using one investment to pay for a different investment. So you need to ask yourself, is buying a home a smart investment right now? As we've seen over the last few years, real estate is not the "safe and sound" investment we thought it was. There's even a chance that home prices are still falling in your area. Or maybe you live in one of the areas that largely avoided the price erosion resulting from the housing collapse.
The point is, you need to understand your local real estate market. You need to know if prices are moving up or down. You need to consider the long-term stability (or instability) of your local housing market. The worst-case scenario would be to use your 401k to buy a house, only to have your property values drop. You would then be losing one investment to cover another investment, and then losing value in the new investment. It's like throwing money away.
On the other hand, maybe real estate is a better investment for your right now. Maybe your 401k isn't doing much at the moment. Maybe your retirement account is actually losing money. Maybe you're in a real estate market that has hit bottom, price wise, and is now starting to appreciate. In this scenario, you might get a better return by shifting the investment toward housing. But again, you have to consider whatever penalties you might face.
Considering Life After Retirement
Lastly, you need to consider the loss of retirement income, since that's what a 401k is supposed to be. During the recession, a lot of people saw their accounts shrink down to nothing. Many of these people later kicked themselves for not withdrawing the money. This adds another variable into the mix -- the safety and security factor. You can see why it's not a question I can answer for you. There are just too many "it depends" scenarios to think about. But hopefully, after reading this article, you'll know exactly what to research and consider.
Here's some recommended reading I want to leave you with. There's an article on Bankrate.com called "10 Ways to Come Up With a Down Payment." It's worth reading. It provides a short overview of different strategies you can use, along with the pros and cons of each. (Web address = http://www.bankrate.com/brm/news/mtg/20020807b.asp)
This article deals with the question: Can I use my 401k to buy a house in 2010? If you have additional questions about the home buying process, mortgage loans, or related topics, you can do a search at the top of this page.
Disclaimer: This article is for educational purposes only. It does not take the place of professional financial advice, nor should it should be construed as such. We recommend that you speak to a financial planner to weigh the pros and cons of using your 401k to buy a home. It's a big decision that should not be taken lightly. Read the guidelines and stipulations for your specific retirement account. Use the IRS link provided early to learn about hardship withdrawals. Make a decision based on research and planning.
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