Buying a house has never been easy, but it would be tough to find a time that was more challenging than 2022. Homebuyers have been put into a vise by multiple economic factors, including high home prices, a historic housing shortage coupled with a spike in demand, and climbing mortgage rates.
Bidding wars are common, and homebuyers are having to use creative tactics to find extra cash for down payments or appraisal gaps. Some homebuyers might even consider tapping their hard-earned 401(k) retirement fund. But is this really a wise decision?
We reached out to real estate and financial experts to learn about the consequences of taking money out of your 401(k) account to buy a house.
A 401(k) is a retirement savings plan offered by many employers. If you have one, it means that you agree to have a percentage of each paycheck deposited into the account. Typically, the employer matches some or all of that sum. Employees choose which funds to invest in, with the goal of creating a nest egg for retirement.
Many financial experts advise against withdrawing money from your 401(k) before age 59.5 as you will have to pay a 10% early withdrawal penalty on the sum you take out.
How To Use Money From Your 401(K) To Pay For A Home
There are two ways to tap your 401(k) to buy a house. You can either take a 401(k) loan or withdraw the funds from your account.
If you opt for a 401(k) loan, know that the amount is limited in size and must be repaid with interest. The maximum loan amount is 50% of your vested account balance or $50,000—whichever amount is less. The repayment deadline is usually five years, and the interest rate varies; right now it’s between 6.5% and 7.5%
On the other hand, a withdrawal from your account is not limited in size, but it will incur that 10% penalty if you are younger than 59.5.
Does Tapping Your 401(K) Affect Your Credit Score?
Taking out conventional loans can affect your credit score, but a 401(k) loan has zero impact on your credit score.
“Getting a 401(k) loan won’t require a hard pull on your report,” says Jeff Zhouhere, a personal finance expert and CEO of New York City’s Fig Loans. “And if you default on your 401(k) loan, it won’t affect your credit history since the national credit reporting bureaus don’t track your 401(k) loan payments.”
Should you tap your 401(k) to buy a house?
Borrowing from your 401(k) isn’t advisable, but some experts say it can be done in a pinch.
“I wouldn’t recommend it, but I will say that a loan from your 401(k) has a flexible repayment schedule,” says Zhouhere.“ You can pay within the five years, or you can pay faster than that without penalty. You can also pay what you borrowed through payroll deductions, but using the after-tax dollars.”
Others urge homebuyers to never remove money from their 401(k) to buy a house.
“I’ve been representing lenders and borrowers for 15 years, and I’d never advise this,” says Matthew Carter, an attorney at Las Vegas’ Inc and Go.
Buyers “might think they are just borrowing the money from themselves, but they are really borrowing it from the future. They’re losing the interest and value they can build on that money to purchase a home that will likely put them into further debt,” adds Carter.
“Homeownership comes with a lot of unexpected costs, and borrowing from your future to suffer those costs is reckless,” he says.
Still, in the current competitive real estate market, tapping your 401(k) might be a worthwhile move, as long as you run the numbers and know that you can afford the fees.
Rising home values alone should make people seriously consider borrowing from their 401(k), says Chris Barnett at eXp Realty in Birmingham, AL.
“Even if you only own a home for a few years, it’s more than likely your home will be worth substantially more than when you purchased,” says Barnett. “I have seen sellers tap $100,000 to $200,000 in equity in their home here.”
“Tapping your 401(k) fund is ideal if you need quick cash for short-term liquidity,” Zhouhere says.
In this situation, a short-term 401(k) loan might be a means to help you make a lucrative long-term investment in a home. Plus, as an investment, real estate historically grows in value better than a 401(k). But, before you draw any money from your 401(k), be sure to consult a financial expert.
Courtesy of Realtor.com