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401(k) for Your Down Payment
But company plans often permit hardship withdrawals if there is an immediate financial need, and that need often includes purchasing your principal residence.
The drawback to a hardship withdrawal is that you must pay taxes and penalties on the amount withdrawn, which often must be paid in the year of withdrawal. And while hardship withdrawals are allowed by law, your employer is not required to provide them in your plan. Check with your human resources department if you're not sure if your 401(k) plan allows hardship withdrawal.
A better approach might be to borrow against your 401(k). You can often borrow as much as 50 percent of your account balance. You will pay interest on the loan, but the interest goes back into your account. The money you receive is not taxable as long it is paid back and plans can give you anywhere from five to 30 years to pay back your loan.
There are risks involved in borrowing from your 401(k). If you lose your job or leave your employer, you must pay back the loan in full within a short period, sometimes as little as 60 days. If the money is not paid back in that time, it is considered a withdrawal from your plan and subjected to the same taxes and penalties. And while 401(k) accounts can usually be rolled over into a new employers 401(k) without penalties, loans from a 401(k) cannot be rolled over.
In addition, because the funds withdrawn from your account are no longer earning compound interest, your account will be smaller when you retire. And you’ll be replacing pre-tax money with after-tax money.
Some lenders will count the money you borrowed from your 401(k) as an additional debt in addition to your car payments, student loans and credit cards, but many do not. While it may seem unfair since you are borrowing your own money, lenders can view it as a obligation that affects your debt-to-income ratio in qualifying for a home loan. That should be a factor in whether you decide to make a hardship withdrawal from your 401(k) and pay tax penalties or borrow against it. Ask your loan officer if your new lender will count 401(k) loans as debt.
Name That Value
At last! You've found your dream home, but there's one thing standing in the path to living in your new home: The down payment.
Some smart home buyers are opting to use funds from their 401(k) program to raise the down payment to buy a home.
Ordinarily, you can't withdraw money from a 401(k) unless you retire, leave the company or become disabled.