A home purchase is a major financial commitment. In order to get the ball rolling, you’ll need a sizeable down payment — typically in the range of at least several thousand dollars. So you may be curious if 401k withdrawals for home purchase are a good idea.
Unfortunately, this big upfront cost can prevent many from diving into their dreams of homeownership right away. If you are looking to buy a house but are short on cash, then it might be tempting to use the funds you need from your 401k.
Let’s take a closer look to see if using 401k to buy a house is the right financial move.
401k withdrawals for home purchase: Is it possible?
If you have a 401k, it is possible that you have a fair amount of savings built up in it. With regular contributions, you might be surprised at how quickly the funds can add up.
However, building savings that aren’t automatically taken out of your paycheck is often a bigger challenge. With that, it might be tempting to pull funds from your 401k to cover the down payment of your home purchase.
And it is completely possible to pull funds from your 401k to cover the cost. However, there are two different options to consider.
The first option is to take a loan from your 401k. In this case, the loans typically require repayment within five years. If you want a loan, you can only borrow so much. The IRS will only allow you to borrow up to $50,000 or half of the account balance.
But there is an exception for these types of loans. If 50% of your account balance is less than $10,000, then you’ll be able to borrow up to $10,000. Importantly, this exception may not be offered through all 401k accounts. It is up to the employer if they want to allow this exception or not.
The second option is a 401k withdrawal. In this case, you wouldn’t have to repay the funds for your retirement. With that, it is the more common choice for home buyers.
The downside is that you’ll have to pay the penalty if you withdraw funds before age 59.5. Unfortunately, it can get expensive quickly to pull funds out of your 401k to cover a down payment. But it is an option if you decide that it makes sense for your situation.
Is using 401k to buy a house a good idea?
So, it is possible to use funds from your 401k to buy a house. But the real question that you are probably asking yourself is, should I use my 401k to buy a house. In most cases, it is not a good idea to buy a house using funds from your 401k. Here’s why.
Withdrawals from your 401k will incur penalties
The first major issue with using your 401k to buy a house is the penalty. If you are withdrawing these funds to cover a home purchase before age 59.5, the transaction will qualify as an early withdrawal.
As an early withdrawal, the IRS will impose a 10% penalty on the funds. That’s a steep penalty! Unfortunately, that is money you’ll never get back. And it can add up quickly. Let’s say you decide to take an early withdrawal of $10,000. That’s a $1,000 penalty right there.
Since saving $1,000 is a lot of money for anyone, the downside of these penalties is that you lose a substantial percentage of the money you worked so hard to save.
The other big downside to using your 401k funds to cover a down payment is the lost opportunity to grow your funds. When your funds are safely tucked away in your 401k, it has a few things going in the right direction.
For one thing, the funds are invested through a tax-advantaged account. That means that you can save pre-tax money and allow your investments to grow. With the power of compounding, these investments can really grow dramatically over time.
If you can allow the funds to grow untouched, it is possible to build a substantial retirement account with time. Saving for retirement is a crucially important goal for a stable financial future. With that, pulling funds out of your 401k prematurely can negatively affect your long-term financial security.
So now that we answered the question "should I use my 401k to buy a house", let's discuss how to save for your home purchase instead!
How to save for a home purchase without using your 401k
Homeownership is an exciting goal that can improve your financial picture. But ultimately, using 401k to buy a house may not be the right move for your financial future.
The good news is that there are other ways to save for a home purchase. Let’s explore the best options to help you save for this major purchase without sacrificing your retirement funds.
Find out how much you need to save
First thing first, consider how much you actually need to save. Of course, buying a home is an expensive endeavor. But you might be surprised to learn that you don’t need to save as much as you think.
Traditional wisdom suggests that you put down at least 20% on a home purchase through a conventional loan. However, the plentiful low money-down loans could mean you don’t need to save quite so much.
For example, you may be able to put down as little as 3.5% with an FHA loan. Or even 0% with a VA loan. Explore your low money-down loan options to see what you might qualify for.
Automate your savings
Once you have a better idea of how much you need to save, it’s time to take advantage of automation. The goal of automation is to take the challenge out of saving. After all, the hardest part is consistently making the choice to put funds away.
Consider setting up an automatic transfer to savings with each paycheck. You may be surprised how this simple step can help you speed towards your savings goal.
Find ways to increase your income instead of using 401k withdrawals for your home purchase
A side hustle is one way you can take control of your income. You could also find a part-time job, ask for a raise or find a better paying job. As you increase your income, you can increase your savings for this big goal.
There is no shortage of side hustle ideas. Take some time to uncover the right fit for your goals. Want some help setting up your side hustle? Take advantage of our free step-by-step side hustle guide.
Save instead of using 401k withdrawals for a home purchase
We advise against 401k withdrawals for home purchases. A home is a major purchase that can help to stabilize your finances. But using 401k to buy a house is not necessarily the right strategy. In fact, most should consider other options to fund their home purchase.
Need some help navigating the home purchase process? Our free course on buying your first home can help you with each step along the way.