One of the employee benefits human resources departments put together is the 401(k) plan. Employees can elect to have the company withhold a certain amount each pay check and have those funds go toward a 401(k) savings account. The funds are withdrawn before taxes are deducted from the pay. The employer can also provide a matching amount if the 401(k) is set up that way and is an excellent tool to begin savings. An employee can elect to have say 5% of their monthly pay check go to the 401(k) account and the employer can match that 5%, doubling the amount in the fund.
Employees like this arrangement because they never really “see” the funds taken out of a pay check as it never hits their bank account. It’s sort of a forced savings plan because once the 401(k) is set up it’s on automatic pilot.
Okay, so how can you use that 401(k) to help you buy a house? One way you can use it is to borrow against it. Most plans do allow for employees to borrow against their 401(k) but not all of them. You’ll need to contact your HR department for all the details. But if you can, it’s a way to borrow the necessary funds to help out with a down payment and closing costs on a purchase with a low-interest, short term loan.
How much can you borrow? There are also rules for that as well. Most plans allow you to borrow up to 50% of your vested balance. If your retirement account shows a $50,000 balance then you can borrow up to $25,000. As well, the loan must be repaid with a loan term not to extend five years. Note that your employer may have different guidelines but they cannot exceed them. You can’t borrow 60% of your vested balance, for example but you can borrow 40%.
Also remember that if you withdraw funds from your 401(k) as a loan, those funds are no longer invested in your various mutual funds or stocks that you selected to be included in your 401(k). As you repay the loan, those payments are not considered contributions. Remember you borrowed them and you’re paying it back.
If setting up a loan seems too complicated you can think about simply withdrawing the needed funds. Your employer however won’t allow you to tap into your funds if you’re 59 ½ or younger. But you can withdraw funds from an existing 401(k) from a previous employer. This is something you might want to talk to your financial planner or accountant about though. You can get hit with an early withdrawal penalty of 10% of the amount drawn and you’ll also have to pay income tax on those funds as well, so make sure you think this through. But if your down payment is less than 20% of the sales price and you’ll be making a monthly private mortgage insurance payment, getting 401(k) funds might make sense.
With an Individual Retirement Account, or IRA, that can also be a resource for help with a down payment and closing costs. If you have an IRA you can take out up to $10,000 to help buy a home. If you’re a first time home buyer, these funds can be withdrawn without paying a 10% penalty, otherwise the 10% withdrawal penalty will apply.
Again, we’re talking about your retirement funds here and once you tap into them they’re no longer working for you, they’re now tied up in the home you buy and you should discuss all matters relating to your retirement with a licensed professional.
While both a 401(k) and IRA can help out, you might want to consider other methods to bring in come cash. Do you have relatives that can provide you with a financial gift to help out? Gifts are an acceptable source of funds for a down payment and costs. Acceptable sources for a gift include any blood relative, spouse, domestic partner or a qualified non-profit. Lenders have specific guidelines they follow to track the source and delivery of the gift money but it’s an excellent option. Or, you can research down payment assistance programs that can help out.
If you’re saving up a little each month to buy a home but it looks like it might be a while before you have enough funds to close and you’ve got either a 401(k) or IRA, it might make sense to leverage these accounts to help. Take your time and look at all your options, but in many instances, it can make sense to use these funds.