You may regret looking through your retirement savings.
If you try buy a house, it is best to make a deposit of 20%. That way, you can avoid having to buy private mortgage insurance (PMI). PMI ensures that lenders do not suffer out-of-pocket losses when faced with a foreclosure. Unfortunately, even though it does not provide you with personal protection, you are paying the cost of the PMI.
A 20% deposit is also useful because it:
- Facilitates home loan approval
- Allows you to borrow less
- Saves money on interest over time
- You are less likely to end up in debt than your home is worth
Unfortunately, many home buyers can find it difficult to come up with a 20% discount. And even finding the money to make a smaller deposit can be a challenge when you’re in an expensive market.
If you choose Now is a good time to buy a home However, if you are having trouble raising the cash for a down payment, you might be tempted to borrow against your 401 (k). After all, if you have a lot of cash in this account it can seem like an attractive source of money that could solve your down payment problems.
Before deciding on a 401 (k) loan, however, you need to consider both the pros and cons of this financial step.
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Benefits of Using a 401 (k) Loan for a Home Down Payment
There are some distinct advantages to having access to 401 (k) funds to cover down payment costs on a home purchase.
- You pay interest yourself. That means you won’t make a creditor richer than if you took out a second mortgage or a larger home loan to cover your down payment costs.
- Loan approval is easy. Assuming you have the money in your 401 (k), regardless of your creditworthiness or other financial references, you should be able to get credit – as long as your work plan allows for credit.
- You can usually access the money quickly and easily. Often times, all you have to do is fill out a few simple forms and you can get the money really quickly, although the exact time frame depends on your plan.
- You can potentially get a better deal on your mortgage. When you make a larger down payment made possible by a 401 (k) loan, you can borrow from a wider range of loans Mortgage lenders. It could potentially also help you qualify for a better interest rate and Avoid PMI.
Disadvantages of borrowing against your 401 (k) to finance your home purchase
Unfortunately, while the advantages of a 401 (k) loan make it attractive, there are also significant disadvantages to consider.
- You are putting your retirement at risk: The money you take out of your 401 (k) is not invested and grows for retirement. Chances are that the return on investment you would have received if you had invested your money would have been greater than the return on investment (ROI) from the interest you pay yourself (or the increase in the value of your home).
- You have less money in your budget. You will need to repay the 401 (k) loan, which means that you will use part of your future paychecks on it. You do not have access to this money for other things, such as Homeownership costs.
- You need to repay the loan quickly. Generally, you only have five years to repay your 401 (k) loan. This can mean making huge monthly payments if you borrow a lot.
- If you are unable to repay the loan, you could end up owing penalties: If you are unable to repay the loan, it will be treated as a payout. You will have to pay normal income tax on it and will also be subject to a 10% early withdrawal penalty if you were not 59½ or older when you withdrew the funds.
- You can expedite repayment if you leave your job: If you are fired or you quit, you must repay the entire loan amount by the tax return due date that year – including any renewals. This can mean having to pay back your loan very quickly or facing penalties.
In many cases, the short repayment period – which results in large payments – combined with the risk of penalties if you cannot repay the 401 (k) loan make borrowing your 401 (k) loan a bad idea. This is especially true if you also factor in the lost chance of profit on your pension account.
We have resources that can provide an alternative to withdrawing money from your 401 (k). These include:
However, you need to consider your individual situation when deciding what is right for you. When you have no other options and you need Take out a 401 (k) loan to qualify for an affordable mortgage and buy a home then you can decide it’s worth it. Just make sure you can make the payments and be aware of the significant risk you are taking before you act.