In Clinton County, NY, “saving for a downpayment” is often cited as the number one obstacle to owning a home.
Sure, some households manage to put money aside each month into savings, but with each passing year, and as home values climb, the required downpayment size grows.
Closing costs can add another several thousand to your bottom-line and make it that much harder to buy a home…. Although many zero money down programs do exist.
This is one reason why buyers sometimes borrow from a 401(k) retirement plan. Some lenders also ask potential clients to do this without educating a client on the potential pit falls.
When you borrow from a 401(k), you can get the money you want for a home in as little as a week and with nothing more than a phone call. And, as you “pay yourself back”, you earn interest on your loan which can make the 401(k) withdrawal seem like a good deal. But, is it, really?
Here’s what you should know when you want to borrow from your 401(k) to buy a home.
What Is A 401(k) Retirement Plan?
A 401(k) is a special retirement program for U.S. employees. The program is sponsored by an employer, and allows employees to make pre-tax contributions to an investment plan.
This means that investments in a 401(k) “come off the top” of your income, before the government levies taxes.
Taxes, in other words, are only paid on what you don’t invest in a 401(k).
The program is named after the 1978 addition of section 401(k) to the U.S. federal tax code which allowed such pre-tax investments. Taxes on paid on 401(k) retirement plans at the time of withdrawal.
There are more than 50 million U.S. workers who are active participants in a 401(k) program.
Using 401(k) Money To Buy A Home
When you invest in a retirement program, such as 401(k), there’s no rule to prevent you from withdrawing your money before you actually retire.
You may have a life emergency, for example, which demands the use of your retirement monies; or, you may need the money to make court-ordered payments.
These types of withdrawals are known as hardship withdrawals, and they come with a 10% tax penalty.
There’s also a provision which allows withdrawals to help with the purchase of a home. Rather than taking a hardship withdrawal, you can actually borrow funds from your 401(k) account with a promise to pay it back.
Arranging for a 401(k) loan can be quick. With just a phone call and some written notes to your plans’ administrator, money to purchase a home be wired to you in as little as a week.
However, just because you can borrow from your 401(k) to purchase a home, that doesn’t mean that you should.
Pitfalls Of Using 401(k) Money To Buy A Home
There are some issues when you borrow from a 401(k) to purchase a home which could raise your total loan costs to a figure much higher than what you borrow. Be CAREFUL!
As one example, during the period your 401(k) loan is outstanding, you’re typically prevented from making full contributions to your existing retirement plan.
This means that you could forgo up to 5 years of retirement fund contributions, which could make a significant impact on you later in life.
And, to compound matters, if your employer is one that matches 401(k) contributions, you miss out on those contributions to your retirement plan as well.
However, the biggest risk to borrowing against your 401(k) is the one of unforeseen circumstances.
Should you borrow against your 401(k) and then leave the company for any reason — including being let go — you will have just 60 days to repay the entire remaining balance of your 401(k) loan.
If you’re unable to make that repayment, the remaining balance is considered a taxable withdrawal and is, therefore, subject to a 10% tax.
When you borrow from a 401(k) to purchase a home in Clinton County NY, then, one of the only ways to “beat the market” is to keep your job through the period of the loan, and hope that the stock market loses massive value throughout the 5-year term of your loan.
Borrowing from a 401(k) loan is a legitimate long-term risk.
Why You Don’t Need To Borrow From Your 401(k)
When you borrow from a 401(k) to buy a home, the decision is based on the premise that a large down payment is needed to purchase a home.
That premise is false. You don’t need to put 20% down to purchase a home.
In today’s mortgage market environment, there is a bevy of low and no down payment mortgage options available which make it simpler to purchase a home than during any period this decade.
There are no fewer than 7 low down payment programs available to Plattsburgh Home Buyers’. Nearly all are backed by the U.S. government, too, which means that they’re not going away soon.
- The VA loan (Department of Veterans Affairs) allows 100% financing
- The FHA loan (Federal Housing Administration) allows a 3.5% downpayment
- The FHFA, which runs Fannie Mae and Freddie Mac, requires just 5% down
- The HomeReady™ program (Fannie Mae) requires just 3% downpayment
- The Conventional 97 loan (Fannie Mae) allows 3% down
- The USDA loan (U.S. Department of Agriculture) requires 0% down
- The Good Neighbor Next Door program (HUD) allows for a $100 down
The newest of these low- and no-downpayment programs is the HomeReady™ mortgage, which is the most flexible, allowing income from all members who live in a household; and, providing below-market mortgage rates to qualified borrowers.
With so many options to purchase a home with less than 20% down, then, there is often little need to borrow from a 401(k). When you borrow from a 401(k), you put yourself at risk. Talk to a mortgage professional to learn about your options..