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Using 401k for Mortgage

Updated on April 25, 2012

401k Exception for First-Time Home Buyer

Contributing to a 401k plan is sound personal finance advice. For many Americans, their 401k plan represents a large chunk of net worth. Over several years, salary deferrals and long-term investing performance can add up to an account with a sizable balance. When that happens, it can be tempting to dip into your 401k for help buying a house. However, there are restrictions on withdrawing from your retirement plan. A 401k exception for first time home buyers sounds like just the ticket.

Unfortunately, there is not such thing. Too many people get confused because there IS an exception for first-time home buyers who want to withdraw from an IRA account, but not for a 401k account. However, there are two possible options that might work for some people to tap into the money in their 401k to buy a home.

First, if you are no longer employed by the company that sponsors your 401k plan, you can roll your 401k into an IRA account tax-free. All it takes is opening an IRA account and submitting the proper paperwork to your 401k plan. Check with your Human Resources department for help getting the right forms, or check your statement for a 1-800 service number. Either way, once your funds have been transferred to an IRA account, you can then take advantage of the special exception for first-time home buyers and make a withdrawal.

If you are still employed by the company that runs your 401k plan, you might still be able to use the money in your account. Many plans offer a loan provision that allows participants to borrow money out of their 401k balance. You can typically only borrow a certain percentage of your account, but it may still be a sizable amount. Interest rates are reasonable because you aren't borrowing a bank's money, you are borrowing your own money. The best part is that when you make the payments you are paying yourself back. Even the interest goes right back into your 401k account.

You do have to make the payments, even though it is your own money. If you don't the IRS considers the amount not repaid as a distribution. That means the amount is fully taxable, and if you are under age 59 1/2, it may be subject to an additional penalty as well.

Check with your plan administrator to see if your specific 401k allows for loans. Although it is a common plan feature these days, there are still plans that do not allow loans at all.


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    • bankscottage profile image

      bankscottage 5 years ago from Pennsylvania

      Good suggestions Hub Llama and they can be very useful for a lot of the right people. But, the recommendations should come with some strong warnings.

      As you point out, a person could get stuck with taxes and or penalties. If the money doesn't get paid back you could leave yourself short in retirement. This can work out great for a lot of people as it sounds like it will for glockr. But, what seems like a good idea, can turn into an nightmare. It is not that you shouldn't do this, it just may not be right for everyone and the should be aware of what could go wrong.

      The Danger Zone:

      1.) If your money is in an IRA, you maybe able to withdraw some or all of it if you are a first time home buyer (not to buy an investment property). If you are under 59 1/2 you won't have to pay the 10% penalty, but, you will still have to pay income tax on the withdrawal. You cannot take a loan from an IRA.

      2.) If you borrow from your 401(k), yes you do pay yourself the interest and that is a positive. But, if you leave your job (willingly or unwillingly), you will be asked to pay the loan back immediately. If you can't pay it back, it will be considered a distribution and you will tax on the loan amount as well as a 10% penalty if you are under age 59 1/2. This could happen even if you don't leave your job. If your company changes plan administrators, the new administrator may not take the old loans and you would have to pay it off the same as if you quit your job.

      Other Options:

      1.) If you have money in an IRA you could roll it over to a Self-Directed IRA and use the funds to purchase investment property (but you or your family cannot personally use the property). This has its advantages, but does come with a lot of rules of its own.

      2.) If you have a whole life insurance policy that has cash value, you can remove some of that money, usually tax-free, or take a loan against it. This money could be used for a house or investment property and like the 401(k) loan, you are paying yourself back. Sometimes you may not even have to pay off the loan, it will just decrease your death benefit. Talk to a life insurance agent for more details.

    • glockr profile image

      glockr 5 years ago

      Borrowing from a 401k to pay (or help pay) for a house is a great idea. My wife and I did that last year to buy a rental house. No loan origination fee (well, $40...) or other junk fees so it was a lot cheaper than getting a mortgage. Also the interest we're "paying" is actually paid "back" to us, so even that is no cost to us. We also have to pay the loan back in 5 years but our rent covers the loan payment.