Does it make sense to tap your 401k to purchase a home? For most families in America one of the biggest staples of wealth is their retirement account. Here is what you might want to keep in mind when you are deciding where to get funds to purchase a house.
To successfully close on a house you really need to have a down payment. The idea that you can purchase a house with no money down is if you’re looking at a VA loan. If you’re an ineligible military veteran or the possibility of a USDA loan in certain specific geographical areas only, you really need to have a down payment. The least down payment that you need to purchase a house is three and a half percent. Well, there are other programs out there such as government grant programs. The rates on those mortgages are typically higher, those programs typically have income limits where you actually get penalized by virtue of not qualifying if you earn too much money and you can also expect higher interest rates on those programs as well. Remember there is no such thing as a free lunch.
So to purchase a house you need at least 3.5 percent down for an FHA 30-year fixed-rate loan. Three and a half percent down of the purchase price, so for example, a $300,000 house is $10,500 as a down payment that you must have. Eligible sources for these funds can be your own personal monies, they can also be gifted monies and they can even come in the gift from your employer believe it or not. A lot of people that might not have money saved up in a particular bank account and don’t have access to donor funds might have a 401k. Lots of people have 401k out there and contrary to popular belief a 401k is a great alternative for coming up with a down payment to purchase a house. Almost every single 401k provider provides options for borrowing on that money to purchase your first home or even a secondary home as long as it’s a primary home that you intend to live in.
So most companies will let you borrow up to 70 percent of the value of the 401k. This is if you do not have any other loans on the 401k. If you have another loan on the 401k the first loan has to get paid off and then you can borrow on the rest of it. Otherwise you might be forced to take a withdrawal which is not to be construed commingled with the idea of borrowing money I’m withdrawing means having to pay taxes and penalties on that money. So you want to have either the loan on the 401k that’s already paid off or no loan on the 401k at all other than the loan that you intend to borrow and want it for the purposes of buying a primary home.
The 401k loan is a fantastic solution because the money is pre-tax so if the payment is say $300 a month on the 401k loan and maybe the interest rate of zero percent or as low as 1 percent. On 401k loans, you could borrow on that money and have a payment of $300 a month and because it is pre-taxed and it will come typically automatically out of your paycheck each month but then it only might feel like the payment is 80 bucks a month or $100 a month because of the pre-tax component. This from a financial perspective could very easily bridge the gap between renting and purchasing a home or between being stuck in a home that you’re growing out of and bridging the gap between where you are and where you intend to go.
Make sure when you’re getting pre-approved with a quality lender that you can appropriately align the 401k money up in unison with your income and the rest of the cash that will be required to purchase a house, e.g. closing costs as well as your debt to income ratio.
A good lender that’s specifically experienced and that has years of loan originations under their belt are more than likely to walk you through the various intricacies of how to set this up the plan for success.
Scott Sheldon is a local mortgage lender, with a decade of experience helping consumers purchase and refinance primary homes second homes and investment properties. Learn more at www.sonomacountymortgages.com.