August 19th, 2020 4:37 PM by Don Spears
Ok, you've finally found your dream home. Now there's just one thing standing between you and your new house: The down payment.
For an easy source of funds for a down payment, many home buyers today choose to use funds from their employer’s 401(K) program. In most cases, you can't take money from your 401(K) plan unless you retire, leave the company or become disabled. But many company 401K plans permit certain “hardship withdrawals” when there is an immediate and heavy financial need, which may include the purchase of the employee's principal residence.
However, using a hardship withdrawal requires you to pay taxes and penalties on the amount withdrawn from your plan, and in some cases must be done in the year of the withdrawal. And while hardship withdrawals are allowed by law, your employer is not required to provide them in your plan. Be sure to check with your employer’s human resources department if you are unsure if your 401(K) plan allows hardship withdrawal.
Another option is to borrow against your 401(K) – often as much as 50% of your account balance. You pay interest on the loan, but the interest will go back into your account. The money you receive is not taxable as long it is paid back and plans can give you anywhere from five to 30 years to pay back your loan.
As with anything, there are risks involved in borrowing from your 401(K). If you lose your job or leave your employer, you must pay back the loan in full within a short period, sometimes as little as 60 days. If the money is not paid back in that time, it is considered a withdrawal from your plan, and thus will be subjected to the same taxes and penalties. And while 401(K) accounts can usually be rolled over into a new employer’s 401K without penalties, loans from a 401K cannot be rolled over.
In addition, because the funds withdrawn from your account are no longer earning compound interest, your account will be smaller when you retire. And you’ll be replacing pretax money with after-tax money. Keep this in mind as you consider financing with your 401K.
Some lenders will count the money you borrowed from your 401(K) as an additional debt that will go along with your car payments, student loans and credit cards. While it may seem unfair since you are borrowing your own money, most lenders view it as a payment obligation that affects your debt-to-income ratio in qualifying for a home loan. It may be a factor in whether you decide to make a hardship withdrawal from your 401(K) and pay tax penalties or borrow against it.