Should You Tap Your 401(k) to Buy a Home?

     I see buyers at every stage of life who can afford the monthly payments on a home loan, but who struggle to come up with the 20% down payment that would give them the most favorable loan terms. Sometimes, people see the money in their retirement account as a way to come up with the cash they need. 

Two Options

     There are two paths to accessing your 401(k): a loan from your retirement account or an outright withdrawal. They sound similar, but the consequences are different.

     A 401(k) loan lets you borrow up to 50% of your vested balance, capped at $50,000. Most plans require a minimum of $10,000. You repay yourself over five years through amortized payments, typically at the federal interest rate plus 1–2%, which puts current rates around 5%. On a $50,000 loan, expect a monthly payment of just under $1,000.

     The important thing to understand here is that a 401(k) loan doesn't count against your debt-to-income ratio for home loan qualification purposes. However, you still need to budget for that $1,000 payment every month alongside your home loan, so you need to do the math to make sure this is something you can afford.

      As long as your financial picture remains steady, you can pay the 401(k) loan off over those five years. However, if you leave your job (voluntarily or not), the remaining balance often becomes due immediately. If you can't repay it, the IRS treats it as a withdrawal, and you'll owe income taxes plus a 10% penalty if you're younger than 59½ years old.

     An outright withdrawal from your 401(k) is even more costly. You'll pay ordinary income taxes on the full amount of the withdrawal, plus the 10% early withdrawal penalty. On a $50,000 withdrawal, someone in the 22% tax bracket could lose more than $16,000 right off the top. Roth IRA holders have a little more flexibility because contributions (not earnings) can often be withdrawn tax-free, but early withdrawal of earnings still carries penalties.

The Case for Real Estate 

     I think investing in real estate is a solid choice, but like other investments, it isn’t risk-free. Although past performance doesn’t guarantee future returns, past performance can reveal long-term trends. Real estate has been one of the most reliable long-term investments in American history. A $50,000 down payment on a $500,000 home, assuming just 2% annual appreciation, generates roughly $10,000 per year in equity growth—a 20% return on your invested capital. That's a compelling number.

     And using retirement funds for a down payment can open a door that might otherwise stay closed. If your 401(k) is your only source of cash for a down payment, it may be your only path to home ownership. A 401(k) loan can be combined with a conventional loan, or even an FHA, VA or seller carryback loan to make a purchase work.

     That said, the money you pull out of your retirement account no longer earns compounding interest. Every dollar you remove today is several dollars you won't have in retirement.

A Word to Parents

     Before you pull money from your 401(k) to lend money to Junior to buy his first home, remember that if the loan isn't repaid, it becomes a taxable withdrawal. For a 65-year-old with $100,000 in retirement savings planning to live off those funds, losing half to an unpaid family loan would be financially devastating.

     There's also the matter of title. If you're considering putting your child's name on a property deed to help them qualify, please talk to a real estate attorney first. I've seen situations where a well-meaning parent added an adult child to title, only to discover that child had borrowed against the property without their knowledge. A Transfer on Death deed can often accomplish the same estate-planning goal—passing the property automatically at death without probate—while keeping control firmly in the parent's hands during their lifetime.

     And Junior may be able to take advantage of a first-time homebuyer loan program with low or no down payment options and competitive rates. This allows Junior to buy a home and your retirement account to remain intact.

     Homeownership is one of the best investments people can make. Just be sure you’re not robbing Peter to pay Paul.

     If you have questions about property management or real estate, please contact me at [email protected] or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery. 

     Dick Selzer is a real estate broker who has been in the business for more than 50 years. The opinions expressed here are his and do not necessarily represent his affiliated organizations.