The Pros and Cons are Borrowing from your 401(k) to Buy a Home
The cost of a down payment on a home rose significantly from 2008 (at the end of the Great Recession) to 2019 (at the cusp of pandemic-related lockdowns early in 2020).
And then After mid-2020, these down payments skyrocketed, according to data from CoreLogic.
The average down payment for a low-tier starter home rose to $30,186 in June 2022 from $26,314 in 2021, Core Logic reported. At the higher end of the housing market, down payments rose to $152,000 from $134,535 in the same period.
401(k) borrowing as a solution?
Given that the current median home price stands at $454,000, most home buyers are struggling to put a decent down payment together
This is why some are now turning to their 401(k) for help.
Your 401(k) is for retirement and in most cases should not be used for anything else, but in this real estate market, some find it impossible to save for retirement and a down payment at the same time.
How do you borrow from a 401(k)
There are many ways to tap a 401(k) for a home purchase and generally fall into two categories, a 401(k) loan or a 401(k) withdrawal
Most financial experts agree that 401(k) loans have substantial advantages over 401(k) withdrawals.
A 401(k) loan has significantly lower costs than a 401(k) withdrawal. A 401(k) loan will not lower your credit score since it's not reported to the credit bureaus. And, your chances of qualifying for a mortgage won't be harmed.
Pros and Cons
There are upsides and downsides to using 401(k) funds to purchase a home, and homebuyers leaning in the 401(k) direction should be aware of them.
Some of the pros of borrowing from your 401(k) include:
A 401(k) loan is not taxable and the interest is paid back to yourself
If used for a home purchase, it can be paid back over 10 years instead of the normal five for nonhome-use loans
You can access your loan funds quickly
There’s no need for a credit check or submitting paperwork for approval
Some of the cons of borrowing from your 401(k) include:
The interest you pay on a 401(k) loan, While it’s owed and repaid paid to yourself, the interest is effectively taxed two times. It’s taxed once when you pay it through salary and it’s taxed again when you withdraw the interest in retirement.
Most plans require the loan to be repaid in full if you leave a job. Any remaining balance may be treated as a taxable distribution. This could be devastating if not handled properly. Given the extended timeline for a home-purchase loan, this is a real consideration for most.
401(k) loans can come with higher interest payments than you may think. With a 401(k) loan, the interest rates are higher than the prime rate, usually by a point or two,
Should you Borrow from your 401(k)
There is no simple answer to borrow or not to borrow from your 401(k) to buy a home. If you are considering it you should talk to an expert. Talk to the experts at Monarch Benefit Advisors to see what the best solutions for you are.