Buying a house often makes a great deal of financial sense, especially if you want to build equity in a property vs. paying rent without owning. For many people, buying a house may first mean overcoming financial obstacles that can stand in their way. One of the financial hurdles one may face is having enough money for a down payment.
The vast majority of mortgage lenders will usually want to see that the buyer has at least 20% of the purchase price on hand before agreeing to the mortgage. If you are thinking, “I don’t have 20% of the mortgage on hand that I would need to purchase the home I want,” you’re not alone. However, turning to your 401K to afford your down payment may not be your best option. Potential home buyers may think about the possibility of borrowing against the value of their 401K in order to help get the money necessary for such a down payment. Below we discuss this option as well as other options homebuyers have to help them reach the 20% down payment needed for a mortgage.
Borrowing from Yourself
On the surface, the notion of borrowing from yourself may seem ideal. However, in reality, doing so can cause all kinds of problems. When you borrow from yourself, 401K borrowing rules state that you have to eventually pay yourself back. You'll also have to pay interest on the payment, interest that may be higher than the rate you're paying on your mortgage. In general, you will have five years to pay this sum back but some employers may extend that period if you use the money to buy a house. These rules vary depending on the employer and the specifics of each 401K Plan.
What Are Some Better Options?
Anyone who is buying a house should consider other options instead of borrowing against their personal retirement savings. A homebuyer should know that 401K borrowing rules may not be working to their advantage. For the most part, if you don’t pay back the loan you could face serious tax consequences including an early-withdrawal fee if you are under 59½ at the time of the loan. Consult a tax advisor for specific tax requirements and implications regarding 401K borrowing rules. Rather than take such risks, you are far better off finding other ways to get a down payment. Consider a loan backed by the Federal Housing Administration or simply buying a house with a lower down payment requirement. Other down payment assistance options include Private Mortgage Insurance (PMI) that is paid along with your mortgage payment until you hit the 20% down payment amount as well as a gift from family with a gift letter specifying the use of the money is for a mortgage down payment.
If you’re a first time home buyer and want to learn more about down payments, where you should get down payment assistance from, and about the entire home buying process, download our free and informative eBook now!