Should you borrow from a 401(k) to support your home?by Tim Manni
A recent report says the number of Americans withdrawing early from their retirement savings to support their homes has grown substantially:
Fidelity [Investments] reported that 62,000 people made hardship withdrawals from their 401(k) workplace plans during the second quarter, compared to 45,000 during the prior quarter, a 37 percent increase.
Fidelity said the top reasons for loans and withdrawals were to prevent foreclosure or eviction, pay for college, or purchase a home.
To some, withdrawing early from your retirement savings may seem foolish. But for others, it may be their only option to stay in their home or be able to come up with a sizeable down payment so they can own a home. Under today’s strict lending requirements, it’s nearly impossible to get private-market financing unless you can put 20 percent down. Twenty percent on a $200,000 loan is $40,000!
HSH.com took a closer look at this growing trend when we wrote and published the article “Should you borrow a down payment from your 401(k)?”
How borrowing from your 401(k) works
If your employer allows you to borrow from your 401(k) plan (most do), you can take the lesser of 50 percent of your vested balance or $50,000. You are typically granted up to five years to pay the loan off, unless you are borrowing the down payment for your first home; in that case, you get more time.
Is borrowing from your 401(k) a good idea?
That depends. First off, you forgo the earnings on that money while it’s not in your account. You repay it with after-tax dollars, so you lose some tax deferral advantages. The biggest risk with borrowing against your 401(k) is that if you lose your job or change employers, you have to repay the loan in as little as 60 days. Otherwise it is treated as an early withdrawal and subjected to the tax on ordinary income plus a 10 percent penalty. On a $50,000 withdrawal, that’s a $5,000 penalty plus $12,500 in taxes at 25 percent. Pricey!
If borrowing from your 401(k) keeps you from making your normal contributions, your cost increases substantially, and if you miss out on employer-matching contributions, the loan could get extremely expensive. Yet if you can continue making your regular contributions while repaying the loan, you aren’t losing much.
Lots of other options
If borrowing from you 401(k) isn’t right for you, it’s important to remember that you still have several other options and alternatives. Have you considered an FHA mortgage? An FHA mortgage only requires a minimum 3.5 percent down. What about a VA or USDA mortgage, which requires no down payment.
Another option is to buy a home with just 5 or 10 percent down. Keep in mind that you’ll have to pay monthly mortgage insurance (MI), and need an excellent credit scores to qualify for MI.
You can also try to get the seller to pay your closing costs. The last option is to apply for down-payment assistance (in most cases, you need to be a first-time homebuyer and meet income eligibility guidelines).
Be sure to read “Should you borrow a down payment from your 401(k)?” in its entirety.
(Gina Pogol contributed to this blog post)