Can You Use Your 401(k) Or IRA to Buy a Home?
Can You Use Your 401(k) Or IRA to Buy a Home?
Even when interest rates are low, down payment amounts rise rapidly when home prices are rising rapidly. Not everybody has the cash savings to come up with a down payment.
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Some people, however, have funds that have built up in an employer-sponsored retirement plan, such as a 401(k).
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If that's the case, you might start thinking about your retirement savings. Can you use your 401(k) to buy a home? The short answer is yes, but there's quite a bit to consider.
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If they're feeling pressured to buy a home soon - interest rates are low, their family is growing, or they find the home of their dreams - homebuyers might not have time to save up for the down payment required.
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The difference between putting 20 percent down on a home compared to lower down-payment options can be significant. Often, 20 percent means landing a lower mortgage interest rate.
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It allows you to avoid paying private mortgage insurance (PMI). Those savings can add up to hundreds of dollars a month.
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Whether it makes sense to use 401(k) funds to access those savings is often a matter of math. If you withdraw from a qualified plan and you're younger than 59 ½, you'll pay a 10-percent penalty and be on the hook for income taxes on the amount withdrawn.
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Will paying those costs upfront to be offset by the years of monthly savings you'll get by paying a lower interest rate or avoiding PMI?
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Consider the opportunity costs.
The penalty and tax hit you take on a 401(K) withdrawal might cost less than years of a higher interest rate and PMI, but there's also an opportunity cost associated with the funds that are withdrawn: Those funds don't grow.
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For example, if you have $30,000 in a 401(k) that earns 8 percent a year and take out $15,000 to buy a home, you'd lose $1,200 of growth in the first year alone.
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Over 20 years at that 8 percent, $15,000 would be worth $69,914. Because of compounding, you'd be giving up quite a bit of retirement savings for that $15,000 down payment.
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Many employer-sponsored plans allow you to borrow funds rather than withdraw them, usually with a $50,000 limit. You'd have to pay back, with interest, any amount you borrow from your 401(k), but you'd avoid the early-withdrawal penalty and tax liability.
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Usually, when you borrow from a 401(k), you must pay the full amount back (plus interest) within five years. When using the money to purchase a primary residence, however, some plans allow for a longer payback period.
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There remains an opportunity cost associated with this strategy. The money you borrow from yourself is not growing in your account. Still, borrowing would be considered more desirable than a withdrawal by most financial experts. Discussing either with a professional is advisable.
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If you have a traditional individual retirement account outside of an employer-sponsored plan, you can use up to $10,000 without paying the 10-percent penalty if you're a first-time homebuyer.
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It might not seem like a lot, but you'd be saving $1,000 compared to making the same withdrawal from a 401(k) or similar plan. You'd still owe income tax on the amount withdrawn.
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A Roth IRA allows you to withdraw any amount you've contributed without paying income tax, although you'd still have the 10-percent early-withdrawal penalty. If you've put in $20,000 over the years, you could take that amount out and pay only $2,000 to do so.
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Most people are able to use funds from a 401(k) retirement account toward the down payment on a new home. Doing so, however, can come with penalties and taxes, and it can substantially stump your savings growth.
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Borrowing from a plan is generally more favorable, and using IRAs that aren't employer-sponsored might be a better first option.
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