Mortgage Down Payment: To Borrow or Not to Borrow from your 401k

Suburban Home

One of the most common obstacles first-time homebuyers face is coming up with the money to pay for a down payment. This is one of the main reasons why some homebuyers consider borrowing from their 401k retirement plans. This way, they could just pay themselves back, and earn interest, seems like a sweet deal right?

Is It a Great Idea to Borrow from your 401k?

No guideline prevents you from taking a distribution from your 401k even if you’re not retired yet. This is called a hardship withdrawal, and it comes with a tax penalty of 10%. You could likewise opt to borrow money or take out a loan from your 401k. But just because you could take a loan from your 401k doesn’t automatically mean that you must do it.

For one, while you have an outstanding balance on your 401k, you won’t be allowed to make full contributions to it. This means that you might be missing out on years of contributions that could drastically affect you later on when you’re retired and need all the funds you could get from your 401k. Also, if you have a generous employer who matches all your contributions, you would also be foregoing those contributions.

But the biggest risk of taking a loan from your 401k has to do with unanticipated circumstances. Let’s say you take a loan and then for some reason leave the company you’re working for, or the company lets you go, you would only be given 60 days to pay off the outstanding loan balance. Furthermore, if you are not capable of making the deadline, your outstanding balance would be considered taxable, and you would have to pay 10% tax again.

The Bottom Line

Put simply, when you borrow from your 401k, you might be able to afford that new home, but you’ll also be putting yourself in significant, long-term risk. Saving money for a mortgage that requires a lower down payment might be better, advises a mortgage lender in Utah. In short, think hard and carefully when you’re considering borrowing from your 401k.