August 12, 2011 – The short, easy answer is “Yes”. However, if you know me, I take buying a home as well as my client’s investments very seriously, so before making an “off-the-cuff” decision to borrower against or cash-out a 401k, I recommend you meet with a professional and discuss a few crucial items.
There are two ways to access your 401k assets to make a down payment on a house.
(1) A 401k Loan
(2) A 401k Hardship Withdrawal
“I think the bigger question is not, ‘How’, but ‘Should You Use 401k Assets To Purchase A House?”
The IRS looks at 401k assets as long-term investments, and therefore, accessing 401k assets can be risky business due to the potential tax and penalty consequences. Of the two options above, the most common and “safe” approach to accessing 401k assets is through a 401k Loan.
A 401k loan is less costly. You simply forgo earnings on the amount borrowed, and pay back the amount borrowed at the rate you were earning the money. From a mortgage pre-approval standpoint, you also need to consider that your 401k loan will be added to your total liabilities, affecting your debt-to-income ratio. Since I help each one of my clients evaluate their situation on a case-by-case basis, so it is hard to say, “One size fits all here” in regards to loan vs withdrawal.
What Are the Risks of Using A 401k Loan?
The major risks outside of paying fees for a 401k loan, is that in the event you lose your job or change employers, you may be required to pay back the loan entirely within 60 days. The loan may now be treated as a withdrawal and you are subject to fees, penalties, and tax consequences.
As for a hardship withdrawal, I will first advise you to speak to your tax professional and investment advisor outside of listening to me. With a 401k Hardship Withdrawal, you pay taxes, penalties, and forgo any future earnings on the money you withdraw. As I mentioned previously, the safest approach to accessing 401k assets is through a 401k loan, but it is wise to consider both options as you research the best financial strategy buying a home.
There are a few factors that I advise my clients to consider before accessing their 401k assets.
(1) Contact a real estate professional to evaluate “real time” market stats in your community (appreciation??)
(2) Contact a tax professional to see the “Total Cost” of a withdrawal
(3) Contact your 401k investment bank for their guidelines on 401k withdrawals and loans
(4) My best advice – Consider asking a relative, friend, or employer to “gift” your the money for a down payment versus taking a costly loan or hardship withdrawal. Interest paid is money lost!
My Best Advice To You
As I conclude, even though it is possible to use a 401k to purchase real estate, I encourage you to evaluate the costs associated with making a financial move as such. As I mentioned above, I recommend exploring other options such as gift funds from a family member or a close friend. You may find that the best option may be to delay the purchase and save up for the down payment, or consider a smaller down payment and pay mortgage insurance.
I hope that you found this information valuable. If you did, please hit the “Like” button below and feel free to share with your friends! I value the opportunity to serve my readers, so please do not hesitate to contact me directly if you may have any questions or are interested in getting pre-approved to purchase a home in Washington State!