Borrowing from a 401(k) can help you buy a home.Here are the rules and risks when doing this move

Financial Planners

By Barbara Marquand

Here’s an overview of federal regulations on 401(k) loans and some tips for choosing this path.

This article is reprinted with permission from NerdWallet.

If you’re struggling to save enough for a home down payment, and especially if you’re hiding more money in that account than anywhere else, a 401(k) loan seems like a quick and easy solution. may look like

According to the Federal Reserve’s Consumer Finance Survey, based on the most recently available 2019 data, the median account value for Americans with a retirement account containing a 401(k) was $65,000. rice field. The median value of trading accounts, including savings accounts, checking accounts, and money market accounts, was $5,300.

Many employer plans allow 401(k) loans, essentially borrowing from yourself and paying interest, which is attractive. Loans are usually not counted as debt when lenders calculate the debt-to-income ratio.

But there are downsides to borrowing from your retirement plan, and some financial planners advise against doing so.

“I generally think people buy homes by renting off a 401(k),” said JP Geisbauer, a certified financial planner and principal at Centerpoint Financial Management in Irvine, California. I don’t like the idea of ​​​​because it’s a risk,” he said.

But Nathaniel Moore, a certified financial planner and president of Agape Planning Partners in Fresno, Calif., says he understands why someone is tempted. “If you’re going from paying high rents to living in your own home, I get it,” he says.

Here are some things to consider if you are thinking about it:

borrowing rules

Most 401(k) plans allow loans, but federal law doesn’t require them. Log on to a website that tracks your 401(k) to verify your loan information, or contact your employer’s human resources department or plan administrator.

Some loan terms vary by employer’s plan, but all plans must comply with federal regulations.

READ ALSO: Mortgage Rates Fall After Fed Signals Stop Hikes.Realtors look forward to busy spring housing season

Risks of Using a 401(k) Loan

Even if you believe a 401(k) loan is for you, it’s important to understand the risks first.

One is the potential tax burden if you miss your quarterly loan payments or quit your job and miss your outstanding balance on time.

Savings for retirement can also slow down. Not only does he lose potential investment returns on the money he borrows, repaying the loan may impair his ability to contribute to his 401(k). In fact, some plans don’t allow employees to make regular contributions until the loan is paid off, said Annamarie Mock, a certified financial planner at Highland Financial Advisors in Wayne, New Jersey. Suspension of contributions is particularly costly if you miss matching contributions from your employer.

But there is another lesser-known risk that Moore is particularly concerned about. It’s that once you get a loan, it’s easy to get it again. “We are reprogramming the mindset to give access to 401(k)s that are protected and designed to provide income in the future,” he says.

Related: I’m 46 and a single mom.Does he have to empty his 401(k) to pay off the house?I have a $128,000 mortgage

Loan costs, repayments and alternatives

If you are considering borrowing from your 401(k), please follow these steps:

Check your plan’s rules for 401(k) loans

Find out details about interest rates, fees, payments, and how long the loan must be repaid.

Calculate if a loan can be paid

Add up loan payments and other obligations.

“That 401(k) loan will be deducted from your paycheck right from the start, so make sure you don’t add up your new home costs, living expenses, and savings and put yourself in the red every month,” Mock says. If you can’t pay the loan, “the only thing you’ll be able to sustain is your credit card debt, which is very expensive,” she says.

Know what will happen if you quit your job

As with most plans, if your plan requires you to pay the outstanding balance in a short period of time, strategize how to pay off that amount to avoid tax consequences.

consider alternatives

Finally, check out other options to help you buy a home, such as low down payment mortgages and state first-time homebuyer programs, Mock advises. Perhaps one of them could eliminate his need for a 401(k) loan.

Some traditional loans have a down payment as low as 3%. FHA loans guaranteed by the Federal Housing Administration have a low down payment of 3.5%. Also, if you are a military or veteran, you may be eligible for a zero down payment veterans loan backed by the U.S. Department of Veterans Affairs. USDA loans for rural homebuyers also require no down payment.

The state’s first-time homebuyer program provides assistance with down payment and closing costs. These programs also offer low down payment loans from approved financial institutions.

Learn more: Thinking about borrowing from your 401(k)? When is it right or not to withdraw from your retirement account?

Still need a 401(k) loan?

Moore offers the following tips:

Learn more about NerdWallet

Barbara Marquand writes for NerdWallet. Email: Twitter: @barbaramarquand.

-Barbara Marquand

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05/11/23 0501ET

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