The pros and cons of tapping your 401(k) for a down payment
Coming up with the cash for a down payment is not easy. If the goal of homeownership is out of reach because of that upfront amount required, you may be tempted to dip into the savings you have stashed for other purposes — like your retirement.
In fact, the Trump administration recently suggested this possibility, proposing to “allow investors to use some of their retirement funds to make a down payment on a house,” said Reuters. It is already an option to borrow against retirement funds through a 401(k) loan, assuming your plan permits it. But is raiding your retirement for a home purchase a financially sound idea?
While the specifics of the Trump administration’s proposal have yet to be revealed, there are some major caveats and drawbacks to 401(k) loans. And generally, taking money out of your retirement, even if you repay it, will reduce your later balance. Here are some pros and cons to help you decide whether utilizing your 401(k) makes sense.
Pro: It is an immediate source of cash for a down payment
The obvious benefit of tapping your 401(k) for a down payment on a house is that it is a quick source of cash, assuming you have built up a decent balance. There are limits on how much you can borrow through a 401(k) loan, though: The “maximum loan amount is $50,000 or 50% of your vested account balance, whichever is less,” said Bankrate.
Con: You have to repay the loan
A 401(k) loan is money borrowed that you will have to repay, even if those payments are technically going back into your own account. Loan payments are typically automatically deducted from your paycheck, which will mean less money to put toward other expenses, including payments on your new mortgage. For repayment, the “time frame is normally no more than five years,” meaning with a “$50,000 loan, that’s $833 a month plus interest,” said Investopedia.
Pro: Interest on a 401(k) loan is paid back to your account
Unlike with a traditional loan, where the interest you pay goes to the bank, interest paid on a 401(k) loan “will go back into your retirement account, although on a post-tax basis,” said Bankrate. As a result, “you are earning at least a little money on the funds you withdraw,” said Investopedia.
Con: You will lose out on potential investment growth
When you take money out of your 401(k), you will lose out on the potential growth of those funds. Even if you repay the full amount, those lost years during which interest could have continued compounding could result in a gap in your retirement savings balance. Plus, “some plans don’t allow employees to make regular contributions until the loan is paid off,” said NerdWallet, putting you further behind.
Pro: No credit check is required
A 401(k) loan “won’t require a credit check or be listed as debt on your credit report,” said Bankrate (though your employer will likely know about the loan). This means that if, for some reason, you are “forced to default on the loan, you won’t have to worry about it damaging your credit score because the default won’t be reported to credit bureaus.”
Con: Leaving or changing jobs will expedite repayment
Repayment expectations shift for a 401(k) loan if you are no longer at the job where you have your 401(k). Should you leave your job, whether because you want to change companies or get laid off or fired, “you must repay the loan by the due date of your federal income tax return or the loan will be considered a withdrawal,” said Investopedia. A 401(k) withdrawal will entail paying income taxes on the amount and, if you are under the age of 59 ½, a 10% early withdrawal penalty.