401(k) Withdrawal for Home Purchase

By Bill Lyons | Published on August 31, 2023

Saving for a down payment and being able to prove your ability to repay a home loan can be challenging, especially if you don’t have a traditional job. However, alternative options exist, depending on your unique financial situation.

If you have a 401(k) retirement account, you may be able to tap into it as income or for a down payment, making getting approved for a home loan a little easier. However, while using your 401(k) to purchase a home might be appealing, there are potential drawbacks to withdrawing from your 401(k).

Keep reading to learn about 401(k) withdrawals for a home purchase.

What is a 401(k)?

A 401(k) is a retirement savings plan commonly offered by employers in the United States. These plans allow employees to contribute a portion of their gross salary to a tax-advantaged investment account to save for retirement.

If you have a 401(k), you contribute to it with every paycheck, and employers may choose to match these contributions. The contributions are then invested in a combination of stocks, bonds, mutual funds, and other assets, growing the account slowly over time, just like any other investment.

The most significant benefit of a 401(k) is that it’s tax-advantaged, meaning contributions are made before taxes, reducing the employee’s tax liability. Then, you’ll pay taxes on the amount withdrawn in retirement.

All retirement accounts have contribution limits, and the 401(k) is no exception. The IRS sets annual limits for these accounts and allows for catch-up contributions for individuals over the age of 50.

The IRS also sets penalties for withdrawals made before the age of 59 ½. If you withdraw money from your retirement account, they’ll be subject to income taxes and an early withdrawal fee. There are some exceptions to this rule, including disability and financial hardship.

Can I Use My 401(k) to Buy a House?

The IRS and lenders allow you to withdraw from a 401(k) for a home purchase, but there are a few caveats. There are different options available to you, and each has its own potential financial implications.

A 401(k) can be used for a down payment and count as income for a home loan. However, the specific details vary depending on the lender and type of home loan. When applying for a home loan, lenders review a borrower’s ability to repay by assessing their income, which can come from various sources like employment, rental, investment accounts, and retirement accounts like 401(k)s.

Withdrawing from your 401(k) to purchase a home can significantly reduce your retirement savings, which can affect long-term financial planning. In addition, there are tax implications for withdrawing early. In most cases, withdrawing early can leave you subject to a penalty.

That said, the CARES Act 401(k) withdrawal for a home purchase waives the early withdrawal penalty for distributions up to $100,000, meaning you may be able to avoid costly penalties when using 401(k) withdrawal for a home purchase.

How to Use Your 401(k) To Buy a House

If you find a lender that allows you to use 401(k) withdrawal for a home purchase, they may have certain limitations. In some cases, you may be able to use your 401(k) with an asset-based loan, where your assets from investment and retirement accounts are converted to income. In other cases, you may be allowed to withdraw from your 401(k) to purchase a home with a more significant down payment.

Before you withdraw money from a 401(k), make sure you check with your agent and your lender on the exact amount needed. The last thing you want to do is not pull enough out and then be forced to go back to try and pull out more during escrow. This kind of late withdrawal can delay closing and cost you even more money.

Here are a few ways you can use your 401(k) to purchase a home:

401(k) Loans

Some employers allow employees to borrow against the amount in their 401(k) accounts for specific purposes, such as buying a home. However, you can borrow a limited amount, and you must pay it back within a certain time frame. With a 401(k) loan, you can avoid the early withdrawal penalty, but you’ll be required to pay income taxes on the amount you withdraw.

Unfortunately, the maximum amount allowed to be withdrawn from this retirement account is only $50,000, so if you need a higher down payment, you might still have to save even more. These loans must be paid back like any other—with interest.

Additionally, some plans may have restrictions in place that prevent you from making contributions to your retirement account until you’ve repaid the loan balance in full. However, in other cases, you can make monthly payments on the loan and continue to contribute to your 401(k) at the same time.

Not all 401(k) plans allow you to withdraw from them to purchase a home. Even if your plan does, it may not be advisable because if you don’t pay the loan back on time, you’ll be required to pay the early withdrawal penalty.

401(k) Withdrawal

The second option to use your 401(k) to purchase a home is to withdraw from it without taking out a loan. The specific purpose you want to take money out of your 401(k) must be classified as a hardship. Unfortunately, not all employers consider purchasing a home a hardship, so this option might not be available to you.

If you withdraw from your 401(k) to purchase a home, you’ll incur the early withdrawal penalty, and the amount you withdraw will be taxed as income.

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Disadvantages of Using Your 401(k) to Buy a House

Withdrawal from your 401(k) for a home purchase isn’t something you should do lightly. In most cases, it’s not advisable because it can affect your retirement planning and set you back if you’re not careful. A few disadvantages of using your 401(k) to buy a house include:

Taxes and Penalties

As mentioned, you may be subject to taxes and penalties if you withdraw from your retirement account before the age of 50 ½. The early withdrawal penalty is 10% on top of the regular income tax owed on the withdrawal amount.

Risking Your Retirement Savings

One of the major downsides of using your 401(k) to buy a house is that it can put your retirement savings in jeopardy. If you make a 401(k) withdrawal for a home purchase, you’ll be taking away money that could’ve been used to fund your retirement.

At the same time, if you take out a 401(k) loan to buy a house, you’ll be deducting from your retirement savings and putting yourself at risk of facing tax consequences if you default. Typically, in the event that you default on a 401(k) loan, the outstanding balance you owe will be treated as a taxable distribution and you will likely face a hefty tax bill as a result.

Given the risks, it’s important to have a well thought out repayment plan in place before taking out a 401(k) loan or withdrawing from your 401(k) for a home purchase.

Alternatives to Using Your 401(k) To Buy a House

In many cases, it doesn’t make financial sense to withdraw from your 401(k) to purchase a house because it can set your retirement planning back. Instead, there are other options for using retirement accounts to purchase a home, such as:

IRA Withdrawals

If you have an Individual Retirement Account (IRA), you might be able to withdraw up to $10,000 penalty-free for first-time buyers. However, the amount you withdraw is still subject to income taxes. You can also withdraw funds from your Roth IRA since some plans count purchasing a home as a hardship withdrawal, allowing you to withdraw $10,000 tax-free to purchase a home.

Instead of withdrawing funds from a standard IRA to purchase a home, you may also convert your IRA to a self-directed IRA (SDIRA) in order to invest in real estate. SDIRAs enable investors to have more control over what they’re investing in and give you the power to invest in alternative assets like real estate.

When you open an SDIRA, you’ll have to find a custodian that specializes in IRAs for investment properties. Once you’ve found a custodian and funded your account, you can purchase investment properties through your SDIRA. Note that you can only use an SDIRA to purchase investment properties and not primary residences, so neither you or your family will be able to reside in the homes purchased through your SDIRA.

VA Loans

VA loans are guaranteed by the Department of Veterans Affairs and provided by private lenders. You may qualify for these loans if you’re an active-duty service member, veteran, or surviving spouse. These types of home loans are a better option than other types of home loans and using your 401(k) to purchase a home because they come with benefits like zero down payment and credit score requirements.

FHA Loans

FHA loans are another good option to help you avoid tapping into your retirement account to pay for a home purchase. FHA loans are backed by the Federal Housing Administration and have low down payment requirements and flexible credit criteria, making homeownership more accessible.

At the same time, if you take out an FHA loan, you might want to weigh the costs of FHA mortgage insurance versus using one’s 401(k). Monthly FHA mortgage insurance is required regardless of your down payment amount and can end up being very expensive over the life of the loan.

Keep in mind that FHA loans aren’t just for first-time buyers, but they make home loans more accessible for individuals that can’t afford hefty down payments. Need more tips? Read our first-time home buyer checklist.

Home Equity Loans

If you already own a home but want to tap into your equity, a home equity loan or line of credit (HELOC) is another option instead of withdrawing from your retirement account early. While these types of home loans are second mortgages with interest rates, they may be a more affordable option than incurring a 10% penalty for withdrawing from your 401(k) early.

Apply for a Loan Through Griffin Funding

There are some instances where withdrawing from your 401(k) account early makes sense, but since there are so many loan options for purchasing a home, it’s usually not necessary to incur the early withdrawal penalty fees or pay income taxes on any withdrawn funds.

Griffin Funding specializes in mortgage loans of all types. Our asset-based loans allow you to use your retirement accounts as income to qualify for a home purchase even when you don’t withdraw funds for a down payment. Learn about your options by contacting Griffin Funding today. Apply now.

Bill Lyons

Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.