Saving up for a down payment can be a major hurdle to homeownership, especially since it isn’t the only expense in the mortgage process. You might need to come up with money for closing costs, moving costs, and modifications or furnishings for your new home as well.
If you’re short on cash, one way you can fund your down payment is to draw from your 401(k). However, this comes with significant drawbacks.
Rules for using your 401(k) to buy a house
You can use the money in your 401(k) to buy a house, but there are some rules you’ll need to follow if you don’t want to pay penalties. Here’s a quick review of how 401(k) accounts work:
- Employees and self-employed individuals can contribute pre-tax dollars from their salaries.
- Employers and self-employed individuals can also make contributions on the company’s behalf.
- Employers can match a percentage of their employees’ contributions.
For 2024, the maximum employee contribution is $23,000. The maximum company contribution and employer match, combined with employee contributions, can’t exceed 100% of your compensation, or $69,000, whichever is less.
When you reach the age of 59½, you can withdraw money from your retirement savings account, paying the current income tax rate on the money you take out. If you’re younger than 59½ (or 55 if you’re no longer with your employer) you’ll also pay a 10% early distribution penalty.
There are some situations where you could withdraw funds from your 401(k) early without paying a penalty:
- Roth 401(k): Since you pay tax on your contributions before depositing them, there’s no income tax taken out when you withdraw money.
- Allowed exceptions: Per the IRS, there are life circumstances where you would be exempt from the 10% penalty, such as illness or disability.
Tip:
Accessing your retirement funds early can be expensive. Since you’ll typically need to pay income tax and a 10% penalty on early withdrawals, make sure you’ve calculated if this is the most cost-effective option.
Ways to use 401(k) funds to buy a home
While it’s possible to fund a down payment from a 401(k), it’s generally not recommended. Still, if you want to proceed, there are two main ways:
- Borrow against your 401(k)
- Make a withdrawal from your 401(k)
These are the key differences between 401(k) loans and withdrawals:
Borrow against your 401(k)
Borrowing from your retirement plan is generally the more advantageous option if you want to tap your plan for a down payment.
If your employer’s plan allows employees to take out loans against their 401(k) accounts, you'll typically be able to borrow up to 50% of your vested account balance or $50,000, whichever is less.
Tip:
If your balance is $10,000 or less, you might be able to borrow up to your entire balance.
You’ll then have to make more or less equal payments — at least quarterly, with interest — until you’ve repaid the loan. You’ll typically need to repay it within five years.
Upsides
- No withdrawal penalty
- Won’t affect your credit
Downsides
- You’ll have to pay yourself back
- Can affect your home loan qualification by hurting your debt-to-income ratio
Learn More: 401(k) Loans: Should You Borrow Against Your Retirement?
Make a withdrawal from your 401(k)
A withdrawal is generally a worse option when it comes to tapping a 401(k) for a down payment.
If your employer’s plan allows for hardship distributions, the IRS allows individuals to take early withdrawals before age 59½ as a result of an “immediate and heavy financial need,” such as buying a home.
While buying a home might not sound like a hardship, that’s how the IRS regulates these types of distributions.
You won’t have to — or even be allowed to — repay the money you take out. You’ll pay regular income tax on the amount withdrawn, and if you’re younger than 59½, you’ll also owe a 10% early withdrawal tax penalty.
Upsides
- It doesn’t have to be repaid
- It won’t affect your debt-to-income ratio
Downsides
- Taxes and the 10% early withdrawal penalty reduce the amount available to put toward your home
- Permanently reduces your retirement savings
Drawbacks to tapping your 401(k)
There are a few scenarios where tapping your 401(k) for a down payment might make sense. For instance, you might consider it if you want to:
- Capitalize on rapidly appreciating home values and/or low-interest rates
- Build equity sooner
- Obtain a more affordable mortgage payment
- Secure a home before you’re priced out of the market
However, it’s generally not recommended to use your 401(k) funds to buy a house, even if the situation appears ideal.
Whether you’re borrowing from your plan or taking a hardship distribution, the decision could have an enduring impact on your retirement savings.
Example:
Your account balance will be lower, and that means any returns you generate will be smaller too. Six percent of $100,000 is $6,000, but six percent of $50,000 is only $3,000 — and the effect compounds over time.
If you’re taking out a 401(k) loan, you might miss out on years of additional contributions and employer matching.
And, if you lose or leave your job, you might have to quickly repay the rest of your loan to avoid having it count as an early distribution that’ll be taxed and penalized.
Learn More: How to Save for a Down Payment on a House
Alternatives to using your 401(k) to buy a house
There are more financially secure ways to speed up your path to homeownership than using your 401(k). Here are four alternatives to look into.
1. Tap your IRA or Roth IRA instead
Best for: First-time homebuyers who need $10,000 or less for a down payment
You normally need to be 59½ to take penalty-free distributions from your IRA, but the IRS allows an exception for qualified first-time homebuyer distributions.
As long as you put any early distributions of up to $10,000 toward buying or building your first home, you won’t have to pay the additional 10% tax on it.
Read On: First-Time Homebuyer? Here’s How to Get the Money for Your Down Payment
2. Get a government-backed mortgage
Best for: Borrowers with low credit scores and at least 3.5% down
Government-backed home loans generally have lower interest rates than conventional mortgages. An FHA loan allows you to put down as little as 3.5% with a credit score of 580 or higher. You can finance the closing costs and upfront mortgage insurance premiums, which means you don’t need to have a lot of cash on hand. If you qualify for a USDA or VA loan, you wouldn’t have to make a down payment.
3. Get a low-down-payment conventional mortgage
Best for: Borrowers with good credit and at least 3% down
With a credit score of at least 620, you can get a low-down-payment conventional loan. Specifically, you might want to look into loans geared toward first-time homebuyers. These include Fannie Mae’s HomeReady or Standard 97 loans, or Freddie Mac’s Home Possible and HomeOne loans.
4. Look into down payment assistance programs
Best for: Low- to moderate-income borrowers who can’t afford a down payment
Programs for first-time homebuyers are available from state housing finance agencies, local nonprofit organizations, federal agencies, local governments, and other entities.
These programs provide down payment assistance in the form of grants, no-interest loans, forgivable loans, and the opportunity to earn sweat equity.
Learn More: 5 Types of Mortgage Loans: Which One Is for You?
Frequently asked questions
Is it a good idea to use your 401(k) to buy a house?
Withdrawing funds early can be costly, since you may have to pay a 10% penalty in addition to income tax. You may also miss out on investment opportunities and potential growth if you use your retirement savings. Evaluate all your options, such as down payment assistance programs, before taking funds from your retirement account.
How to borrow from a 401(k) for a down payment?
You can borrow funds from your 401(k), as long as you repay the money within five years (with interest). Your employer might set its own limits, but you can typically borrow up to $50,000 or 50% of your vested balance, whichever is less. Unlike an early withdrawal, you won’t need to pay taxes or penalties on a 401(k) loan if you repay it on time.
How much can I pull from my 401(k) to buy a house?
If you’re taking out a hardship withdrawal, the amount you can access depends on your immediate financial need. The funds you withdraw will be considered taxable income and could be subject to an additional 10% penalty. If you’re using a 401(k) loan, you can borrow up to 50% of your vested interest or $50,000, whichever is less.
How do I avoid taxes and penalties on my 401(k) withdrawal?
To avoid paying income tax plus a 10% penalty, you can take out a loan instead of withdrawing funds from your retirement plan. As long as you pay the loan back within five years, there won’t be penalties assessed. If you are at least 59½ years old or using a hardship exemption, you won’t need to pay a 10% penalty.
