Can you use a 401k to buy a house?

Buying a house is a huge financial obligation. Not only do you likely need to come to the closing table with a down payment and closing costs, but you also have to secure a reasonable monthly payment on your mortgage, as well. To cover these costs, you may have considered tapping into your 401(k) funds — whether through a loan or a withdrawal — to help buy a home. 

If you withdraw money from your 401(k) to buy a house when you’re under 59½ years old and still employed, you’ll have to pay a penalty and taxes. As an alternative, you can take out a 401(k) loan, borrow from an IRA account, or take out a government-backed loan with better mortgage terms.

401(k) withdrawal rules for home purchase

You are not supposed to withdraw funds from a 401(k) until you turn 59½ and retire. The IRS makes some exceptions, including for hardship withdrawals that are made “on account of an immediate and heavy financial need.” 

Hardship distributions include funeral expenses, medical expenses for you, your spouse, or dependences, repairs from a declared disaster, costs directly related to the purchase of a primary residence (not a rental property), and housing payments to prevent eviction or foreclosure. You are only allowed to withdraw the amount needed to cover the need. Ultimately, your employer decides what counts as a hardship withdrawal (including buying a house), and you may need to present evidence of hardship before the withdrawal is approved.

Even if you do qualify for 401(k) hardship withdrawal, you may incur a 10% early withdrawal penalty on the sum withdrawn. You’ll also have to pay regular income tax on the amount you withdrew, since this type of retirement account is funded with tax-free contributions. Taking money out of a Roth 401(k) won’t have the same income-tax consequences (since you already paid taxes on the money used to fund the account), but you may still have a withdrawal fee. 

There are a few exceptions to the 10% penalty rule outlined by the IRS, like if you’re getting divorced and need to divide assets, you become permanently disabled, or you need to pay certain unreimbursed medical expenses. Buying your first home is still subject to the 10% penalty. 

If you’re over 59 ½ and retired, you do not have to worry about penalties. You can read more on senior mortgages and homebuying after age 60 here.

How to use a 401(k) to buy a house

If you want to buy a home using your 401(k), there are two ways to go about it: borrowing funds from your account or making a direct withdrawal. In both cases, the funds can be used for covering your down payment or closing costs. However, it's important to be aware that each option carries distinct financial consequences. Here’s what they look like at a glance:

Taking out a 401(k) loan

You can borrow money from your 401(k) account to cover a down payment and you’ll avoid paying both the 10% penalty and income tax. The maximum amount you can borrow with a 401(k) loan is $50,000. However, just as with other loans, you must pay interest — usually between 1% and 2% — and you cannot contribute additional funds to your 401(k) account until you’ve repaid the loan. That means you will not be able to receive employer contribution matches, either, if your employer offers that perk. 

A 401(k) loan basically freezes your retirement account in exchange for a quick influx of cash. Credit reporting agencies also won’t take your 401(k) loan into consideration and it won’t count toward your debt-to-income ratio, so using this loan shouldn’t affect your ability to qualify a mortgage. 

Every plan provider offers repayment terms, but the longest time you’ll have to repay is usually five years, which means it could be half a decade until you can actually start growing your retirement savings in the account again. 

Here’s what else to know:

• Your employer may allow loans: Since these retirement plans sponsored by your employer and some plan administrators may not allow you to borrow against it for a house or for anything else.
• You can’t write off the loan payments on your taxes: As you repay the loan, these payments are not tax-deductible. In the IRS’s eyes, you’re paying back a loan, not contributing to your retirement, so you cannot reduce your income by the amount that you repay. 
• You’re not off the hook if you leave your current job: Getting fired, let go, or quitting your job does not get you off the hook for paying back a 401(k) loan. In fact, your repayment period shortens so you’ll have to repay the loan in full by the next tax filing date. 
• If you don’t repay the loan, it will be considered a withdrawal: 401(k) withdrawals have their own rules but firs off know that you’ll have now have to pay penalty fees and income tax on the withdrawal, in addition to all your loan payments with interest. 

Making a 401(k) withdrawal

If your plan doesn’t allow 401(k) loans and you want to use retirement savings for a down payment, you can make a withdrawal. You don’t have to repay a 401(k) withdrawal and you can keep contributing to the account afterwards.

While the purchase of a home may qualify for a hardship withdrawal, but will still likely incur the 10% penalty. Buying a principal residence does sometimes count as a special exemption but it’s very hard to qualify since you’ll have to prove that you have no other resources to buy the house. All of your assets that could be used to buy a home will be considered. The IRS views retirement savings as a last-ditch resource, so they are unlikely to waive the penalty. Even if they do, you still must pay income tax on the withdrawal.

If you have more questions about whether you’ll pay the penalty, contact your retirement plan administrator and a financial advisor. 

Should you use your 401(k) to buy a house?

The best option for using your retirement savings is to obtain a 401(k) loan rather than making an outright withdrawal. This way, you’ll avoid the 10% penalty and income tax. Additionally, a retirement account loan doesn’t count toward your debt-to-income ratio, and credit bureaus won’t count it — both of which will help you obtain better mortgage terms.

However, keep in mind that taking money out of your 401(k) can put you behind your retirement savings.

Pros

• Access to funds: If you're a first-time homebuyer or facing limited options for down payment funds, tapping into your 401(k) can provide a source of readily available cash.
• Avoiding mortgage insurance: Using your 401(k) to increase your down payment might enable you to reach the threshold (20% down) required to avoid paying private mortgage insurance (PMI). This can potentially save you a significant amount over the life of your mortgage.
• Competitive interest rates: A 401(k) loan  may offer lower interest rates compared to traditional loans. This can save you money on interest payments over time. If you’re also using the 401(k) to make a hefty down payment, you may also be able to get competitive mortgage rates.

Cons

• Impact on retirement savings: Withdrawing from your 401(k) depletes your retirement savings, potentially jeopardizing your financial security in the future. The compounded growth you would have earned on those funds is lost, and it may be challenging to catch up on contributions later.
• Loss of employer contributions: Some employers match a portion of their employees' 401(k) contributions. When you withdraw funds, you may forfeit these valuable employer matches, effectively leaving "free money" on the table.
• Tax Implications and penalties: If you choose to withdraw funds from your 401(k) before the age of 59½, you'll need to pay income taxes on the withdrawn amount and likely an early withdrawal penalty of 10% adding to your total costs. 

Alternatives to 401(k) withdrawals for buying a home

If you want to use retirement savings to buy a house, there are a few better alternatives, including one hiding in plain sight.

IRA and Roth IRAs 

An IRA is an individual retirement account that you open on your own and isn’t sponsored by an employer. Unlike 401(k)s, IRAs are retirement accounts that have special provisions for first-time home buyers — which are defined as people who haven’t owned a primary residence in the past two years.

If you have an IRA account, you may be able to withdraw up to $10,000 for your home purchase without incurring a penalty. That $10,000 is still subject to income taxes, but you won’t be slapped with that extra 10% like you do with a regular 401(k) unless you go over that withdrawal amount.  You won’t have to pay taxes when you withdraw contributions from a Roth IRA though, since you funded the account with post-taxes dollars.

Before you tap your regular 401(k) look to your IRA, if you have one.

Government-backed loans

FHA loan or VA loans are designed to make it easier for first-time home buyers to obtain a mortgage with lower down payment and financial requirements, making it particularly useful to people who don’t have funds on hand or have lower (or even bad) credit scores.

FHA loans require a minimum down payment of just 3.5% to 10% depending on your credit score. Still, FHA loans may make it possible to buy a house without incurring significant penalties from tapping a 401(k).

If you’re an eligible service member, veteran, or spouse of a service member or veteran, you may qualify for a VA loan, which doesn’t require any down payment at all. VA loans are a clear alternative to tapping your 401(k) or other retirement savings if you qualify. Keep in mind that VA loans have their own pros and cons.  

FAQs

Using a 401(k) to buy a house can get confusing. Here are more answers to help understand the process.

Can I take money out of my 401(k) to buy a house ?

Yes you can use a 401(k) to buy a house. However, the specific rules and implications vary depending on your employer's retirement plan and the options available within it. 

What is the penalty for borrowing from a 401(k)?

You don’t have to pay a penalty for borrowing against your 401(k) but if you’re under retirement age (59 ½) you will have to pay income taxes and a 10% penalty on the withdrawal amount.

What is a 401(k) hardship withdrawal?

The IRS allows for early withdrawals from your 401(k) before you reach retirement age for difficult circumstances and hardships, including: declared disasters, paying tuition, medical expenses, and the purchase of a primary residence. Hardship withdrawals may still be subject to a 10% penalty fee. 

Are there any special exceptions for first-time homebuyers and 401(k) accounts?

First-time homebuyers may withdraw up to $10,000 from their 401(k) to cover the down payment and closing costs, but their withdrawal may still be subject to a penalty of 10%, which doesn’t make it a useful resource. If you’re buying your first home, look for a down payment assistance program, which is offered by many states, to help cover costs.  

Should you max out a 401(k) before buying a house?

Deciding whether to max out your 401(k) before buying a house depends on your priorities. If retirement is your primary focus and you have time to save, maxing out your 401(k) can help secure your future. However, if a home purchase is imminent and you need immediate funds for a down payment, you may need to balance your contributions between the 401(k) and saving for a home.

Is it a good idea to use a 401(k) to buy a house?

Buying a house is a huge financial commitment. It’s understandable that you’d want to lessen that financial commitment by coming up with a larger down payment. But doing that by withdrawing from your 401(k) could put you in even more of a financial bind since it will deplete your retirement funds. If you’re thinking about tapping your retirement savings, explore other options first, and make absolutely sure that you’ll be able to get your retirement accounts back on track.