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When to Leverage a 401(k) for a Home Down Payment

Wondering where to get the money to make a down payment on a new home? As home prices quickly increase, the amount to make an optimal 20 percent down payment also increases. Meanwhile, you may already have a substantial nest-egg built up in a 401(k) if you’ve been working for years. 

Check out our down payment calculator

Are My Retirement Savings Worth a Down Payment?

Conventional wisdom suggests that you don’t touch the money accumulated in your 401(k) until you reach retirement age. The tax advantages of putting money away in a 401(k) are lost if you pull the money out early. What’s more, the fund in which your money is invested will usually charge you their own early withdrawal fee.

While buying a home could be the biggest (and best!) investment you will ever make, having a healthy 401(k) is a key part of your long-term financial plan. Gutting your 401(k) now could leave you ill-prepared for retirement. Fortunately, there is a way to take advantage of the savings in your 401(k) without sacrificing your long-term plan.

Borrowing from Yourself for a Down Payment

When to Leverage a 401(k) for a Home Down Payment

Instead of making a straight withdrawal out of your 401(k), you could instead take out a loan from it. This is a great helpful way to supplement your down payment.

While you can borrow against your 401(k), note that you will be paying back yourself for the loan’s principal and interest, not to a bank. Rates usually compare well to mortgage rates. So since you’re borrowing from yourself, you will have a variety of repayment options, from monthly payments to lump sums.

A 401(k) Loan vs. Mortgage Insurance

Let’s look at two possible scenarios for a purchase of a $300,000 home.

Suppose you have $15,000 in cash for a down payment. You have a credit score of 700. If you take out a mortgage at $285,000 at 5 percent interest, your monthly payment will be $1,530. But with a loan to value ratio of 95 percent, your monthly mortgage insurance cost will be around $220. Your total monthly obligation would be $1,750. This would be the payment for the first five years, until the mortgage insurance dropped off.

If you have a 401(k) worth at least $90,000, you can borrow up to 50 percent of it. This allows you to only take a mortgage loan of $240,000 (80 percent of the purchase price) and avoid mortgage insurance. The mortgage payment would be $1,288. In this scenario, your 401(k) loan will be for $45,000.

If your 401(k) loan is also at 5 percent interest, on a typical five year repayment, your payments to yourself will be $850. This makes for a total monthly payment in the first five years of $2,138. While this is significantly higher than in the mortgage insurance scenario, remember that the $850 is coming straight back to you. After the five years, your monthly payment for the remaining 25 years would be almost $250 less than in the first scenario.

The Takeaway

When to Leverage a 401(k) for a Home Down Payment

Financing a home with a 401(k) loan is not for everyone. Obviously, if your monthly income can already barely support your mortgage payment, taking on a five-year payment on a 401(k) loan will be difficult. Even if you can structure it with a lump sum payment, you will still have to qualify as though you were making monthly payments. But for home buyers with good cash flow and minimal non-401(k) savings, this plan could be the perfect way to finance your new home. Before making any decision you don’t feel confident with, you may want to talk to an expert, like a financial advisor, to help you weigh all your options.

Tips for Financing Your Down Payment

  • It’s not always easy to put down thousands of dollars at once when it comes time to buy a home. The general rule of thumb usually lands a down payment at 20% of the purchase price. However, you aren’t required to put that much down and you may even have access to some low down payment mortgage options that you didn’t know about.
  • You should only really take out a 401(k) loan as a last resort. You’ll want to make sure you’ve exhausted all other options before you turn to your own retirement savings. Unsure of what other options you have? You can definitely look into a down payment assistance program. You can check with your lender, housing authorities and even non-profit organizations.
  • If you’re going to use your 401(k) for anything other than your retirement, a down payment is one of few exceptions that can make financial sense in certain circumstances. Other than that, there are only a few situations when you should borrow against your 401(k). Again, using your 401(k) would still be best used when no other options will work for you.

Photo Credit: ©iStock.com/Sezeryadigar, ©iStock.com/KittisakJirasittichai, ©iStock.com/andresr

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Gregory Erich Phillips Gregory Erich Phillips is a twelve year veteran of the mortgage industry. He is an active mortgage loan officer and a trusted resource on home financing and real estate trends. As a writer, Phillips is known for his works on economics, personal finance, religion, politics and culture. Follow him on Twitter @by_gep.

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