You've found your dream home and are now wondering, "Should I borrow from my 401(k) to buy a house?" You can use a 401(k) for payment towards a new home, but before you do, it's crucial to take a look at the disadvantages that come with it. However, there are advantages as well.
Ultimately, it's up to you to decide whether or not you can take such a risk, but you should make sure you're covered with a home insurance policy. The following tips and bits of advice can help you answer this common home buying question.
Using a 401(k) to Pay for a House
You've worked hard for years, and have a decent amount of money saved up in a retirement savings account. When the opportunity arises to buy the home of your dreams, it's quite tempting to dive into that stash of cash and get the house you really want. However, doing so can be more trouble than it's worth in the end.
You may reassure yourself about any concerns by telling yourself that it's okay since you are paying interest to yourself, and not to the bank. The question of whether to borrow from that account to buy a house can be better answered by taking a look at some of the benefits and risks.
Benefits of 401(k) House Payments
For most people, the biggest benefit of using a 401(k) to pay for a house is that the money is available, and can get you out of a bind, or ensure that you have the amount you need to pay for the home that you really want. This is especially true for older adults who are nearing retirement and feel as though they have worked hard enough for the money, and now it's time to spend it on a dream house.
There are two ways you can use a 401(k) to make payments: through a hardship withdrawal or a 401(k) loan. Either way, you will probably be able to get the money you need for the home you want. If you want to take the money out of your savings, you may be able to qualify for a 401(k) hardship loan. Although this money is generally meant for retirement savings, you can still use it to purchase a primary residence.
Another possibility is a 401(k) loan. As opposed to seeking a hardship withdrawal, almost anyone can take out a 401(k) loan against their retirement plan. One benefit of this move is that any interest you pay can go right back to your retirement account. According to 401kcalculator.org, this means that if you need to borrow $4,000, and you pay back $4,750 overall, that extra $750 is returned to your plan.
Drawbacks of 401(k) House Payments
There are limitations involved whether you are borrowing against your account or withdrawing money from it. For example, your employer may not even allow you to borrow against your account, especially if you work for a smaller business or a nonprofit organization. Any interest rate you may have been paying in your 401(k) account is no longer relevant.
For example, according to the site, if your account had six percent earnings, that is the cost of the loan to you, and you will no longer receive the account earnings. Account withdrawals before retirement can be quite costly, with associated extra fees and payments. Taking money out of a 401(k) early also means that you forgo any earnings you could have made on the money you withdraw.
You should also take into consideration whether you have an emergency fund for unexpected events, such as health expenses or a job loss. If you can't afford to buy a home without taking from your 401(k), you may not have enough to cover the expense of home ownership right now. These costs can quickly add up, leaving you in a financial bind.
For home buyers, particularly younger adults, who do not have the amount needed to make a down payment, it's probably best to wait. Financial planner James Holtzman says that this is especially true for home buyers who do not have enough money to meet the minimum 20 percent down payment.
In such situations, the cost of private mortgage insurance (PMI) is usually added in, along with any home maintenance, property taxes, and other fees. Young adults may also be carrying student debt or car loans. Holtzman suggests that it is best to rent for awhile longer, "…pay down those other debts and save up some more to make the minimum down payment required."
If you are struggling to come up with the money to pay for a primary residence, you may be tempted to use your 401(k), because you know that money is available. It may not be the best answer, however, particularly for younger home buyers. In addition to house payments, there are other costs to be aware of, including insurance. A qualified independent agent can help you find affordable homeowners insurance. Before you withdraw money, ask yourself, "Should I use 401(k) funds to pay for this house?"