It’s not uncommon for homebuyers to tap into their 401K or other savings when coming up with a down payment. Buying a house is expensive and putting down 3% to 20% can be difficult without using your retirement savings. Here’s a look at the two ways you can use your 401K towards the down payment on a house.
Making a 401K Withdrawal
The first way to use your 401K savings for our down payment is to make a withdrawal. While you can certainly do this, you will pay a penalty when you simply withdraw money from your 401K account. This is not the most advantageous way to access the case you have saved for retirement.
Borrow from Your 401K
Another way to access the money in your 401K for a down payment on a house is to borrow from it. You can borrow up to $50,000 or half the value of the account, as long as you plan to use the money for a home purchase. Often, the interest rate will be two points above the prime rate on this type of loan.
While this is a great way to avoid paying a penalty, you will have to repay the loan. In addition, you will need to disclose this information to your lender for the mortgage, as well. It’s also important to keep in mind that if your employment ends before you have repaid the loan in full, you will likely have a 60-to-90-day repayment window for the outstanding balance. IF you don’t repay the loan in this amount of time, you will have to pay regular taxes and a 10% penalty as the loan will be considered an early withdrawal.
Comparing a 401K to Mortgage Insurance
If you’re in a situation where you don’t necessarily need to borrow against your 401K to get approved for a mortgage, you may want to consider your options. Maybe you’re considering a 401K loan to avoid paying private mortgage insurance. For most home loan programs, you will need a 20% down payment to avoid paying private mortgage insurance, but you may be able to get approved with a smaller down payment.
In most cases, taking out a 401K loan will lead to a higher overall monthly payment between the 401K loan and the mortgage payment compared to a mortgage and private mortgage insurance. However, after you pay off the 401K loan, your total monthly payment will be lower compared to a mortgage with private mortgage insurance.
Using your 401K for the down payment on your house will cost you in one way or another. There isn’t really a way to just use the cash without taking out a loan or paying a penalty for withdrawing money from your 401K. Consider all your options before deciding to take out a loan or make a withdrawal and make sure to compare the difference in payments versus private mortgage insurance.