Is it a good idea to borrow against your 401(k) to get the down payment to buy a home? If your employer allows you to borrow from your 401(k) plan, and most do, you can take the lesser of 50% of your vested balance or $50,000. The typical repayment term is five to fifteen years.
The interest you pay on the loan is not an issue, since you are borrowing from yourself, you would simply be paying interest back to yourself. One of the biggest downsides to borrowing against your 401(k) is that you are borrowing pre-tax dollars and paying the loan back with after-tax dollars. Hence, although the interest cost is meaningless since you are paying interest to yourself, there is a cost since you are taking out out gross dollars and paying them back with net dollars.
And If borrowing from your 401(k) keeps you from making your normal contributions, you will miss out on employer matching contributions, and you will miss out on growing your 401(k) for those years you are repaying your 401(k) loan. The bottom line is, when you are borrowing against your 401(k), you are not saving.
And if you lose your job or get laid off at the employer where the 401(k) loan is based, you will have to pay the loan off quickly (usually within 60 days), otherwise it is treated as an early withdrawal and subjected to the tax on ordinary income plus a 10 percent penalty.
The upside is that it may make your dream of home ownership come true, where it otherwise may not. Or you may have some cash saved for a 10% down payment, but a 401(k) loan may give you extra cash to reach to a 20% down payment and avoid mortgage insurance. Mortgage insurance can be incredibly expensive, and a 401(k) loan may come out as the cheaper alternative. And a 401k loan, even given the downsides, can be the cheapest forms of borrowing right now, cheaper than credit cards, borrowing from family (unless your family will give you a gift with no repayment expected), and cheaper than borrowing more on your mortgage.
You should ask an experienced mortgage professional to carefully weigh options if you are considering a 401(k) loan. You may also want to consult an accountant or financial planner.
In my opinion you should not use a 401k loan to get a down payment on a house. You should reserve 401k loans for emergencies, such as medical emergencies and home foreclosures. A home purchase is not an emergency. It is better to rent until you can save up for a down payment on a house.
ReplyDeleteHi all,
ReplyDelete401k loans offer peace of mind, that in an emergency you can access these monies without any tax penalty to get through a tough time. The loans are allowed by federal law and internal revenue service tax code, there is no requirement that they be offered on any particular plan. Thanks.
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