Should You Use a 401k Withdrawal For Home Purchase? (Pros/Cons)
By James Young on September 19, 2013
Your 401K is one of the most powerful retirement investment vehicles you have, and the best way to make it grow is to keep investing and leave it untouched until you’re well into your 60s. But sometimes, life throw’s a curve ball and you need a lump sum to meet a major life expense – like purchasing your primary home. In other words, should you use a 401k withdrawal for home purchase?
Taking money from your 401K seems like a good choice – it’s your money, so why shouldn’t you use it? Most retirement blogs or guides you read warn strongly against 401K withdrawals, thanks to penalties and fees for tasking your money out early (this is a retirement account, after all). But is it always a bad choice? And what are your alternatives?
Instead of withdrawing money from your 401K for your down payment:
- Consider taking a second mortgage from your lender – or from another lender – to cover the down payment.
- Ask your lender if they can provide a larger mortgage – say 90% or 95% of the home’s value – by having you pay private mortgage insurance. PMI will increase your monthly costs – so be sure and add that into your “can-I-afford-this-mortgage” calculation – but it’s one more way to get you into the home you want.
- Take a loan from your 401K. Many people don’t know they can use their 401K as a source of loans (assuming your employer allows it). In this scenario, your account serves as a lender; you pay interest, but that interest is paid back into your account, to help make up for the earnings you’ll lose by taking out some of the principal. Here, the major risk is that if you lose your job before paying back your loan, you have to pay back the loan in full within a pretty short period of time – usually a couple of months – or else it will be considered a withdrawal and all those penalties will apply.
So how do you decide which is the best option for you? The first steps are to determine what your options really are:
- Ask your employer if they allow loans from your 401K account; if they don’t, obviously this option is off the table.
- Ask your lender if they’ll loan more with the option of PMI.
- Shop around to see if you can qualify for a second mortgage to cover the down payment.
Once you know what options are available to you, you need to sit down with a calculator to figure out which option is the best choice for your budget and your income.
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