First Time Home Buyer? How to Use Your 401(k) as a Down Payment

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As a mortgage loan originator, I’m used to problem-solving with clients in unique situations. And recently, I helped a time-crunched and cash-strapped couple buy their dream home in a way you may not have considered.

The call came on a Monday morning from Mark and Katie, both in their early 30s. Within minutes I could tell I had been first on their to-do list for the week. These nervous brand-new parents had made up their minds: They needed to buy their first home.

The arrival of their new baby girl had kicked their original five-year plan into turbo drive. Not only did they need to upgrade from their one-bedroom, 650-square-foot apartment; they needed to make their home purchase happen before both the end of Katie’s maternity leave and the expiration of their apartment lease… in 60 days.

That did not give my anxious clients sufficient time for the perfect home-buying scenario, so we jumped right into what options they did have… most importantly, what funds they had available for the down payment.

Unfortunately, Mark and Katie had only one-third of what they needed for a down payment. But they had both done a great job of socking away money in their retirement plans. It was clear we needed to utilize their 401(k) and thrift savings plan (TSP) funds to cover the remaining two-thirds of their down payment.

We started with two questions to figure out their maximum down payment potential.

Question 1: What is your current vested balance?

Your vested balance does not equal your total balance. Instead, this term refers to how much of your employer-sponsored plan would go with you if you were to leave your job or withdraw your 401(k) right now. While every dollar you contribute to your 401(k) is your money, the company-matching funds in your account are not immediately all yours. Every year, a certain amount of the matching funds is “vested.” Once you’re fully vested, you can then claim the entirety of the employer match.

Note: Every employer is different with regard to the vesting period, and you will want to speak with your plan administrator if you have been with the company for fewer than six years (typically the maximum amount of time an employer may withhold a portion of their contributed dollar). The IRS has a helpful entry on this topic.

Below is a snapshot of what Mark and Katie’s retirement plans look like:

Mark’s 401(k) Katie’s TSP Katie’s IRA
Ending Value $129,882.71 $12,458.25 $24,252.00
Vesting Value $129,882.71 $8,198.23 No Vesting

Mark has been with his company for almost ten years and is fully vested… allowing him to consider the full value of his TSP plan.

Katie has been with her company just over two years and is only 20% vested. She also had a 401(k) at a previous employer rolled over into an IRA.

Question 2: How much are you able to withdraw or borrow from your 401(k)?

The answer to this question depends entirely on your current scenario and the goal for the down payment.

Since both Katie and Mark are first-time home buyers (no ownership interest within the most recent three years), they have three different options to consider:

  1. Take a hardship withdrawal
  2. Take a 401(k) loan
  3. Take both hardship withdrawal and 401(k) loan

Hardship Withdrawal Option:

If you have an IRA, the IRS allows for a $10,000 withdrawal per person under the age of 59½ to avoid the 10% penalty under specific circumstances (including first-time home purchase); however, they will be required to pay income tax on the amount withdrawn. 401(k) providers will provide the consumer with the option to take the income tax either at the time of withdrawal or when filing taxes. All examples provided are assuming the consumer will use the tax payment at the time of filing tax returns. For more information, see the IRS website.

Mark’s 401(k) Katie’s TSP Katie’s IRA
Accessible Value $129,882.71 $8,198.23 $24,252.00
Hardship Withdrawal Allowed w/o Penalty 0 0 $10,000

Total for Down Payment: $10,000

401(k) Loan Option:

The following rule is strict. You may take a loan of the lesser of these two options: 50% of the vested 401(k) balance or a maximum of $50,000.

The next important factors to consider will vary with each employer:

  1. Loan period (typically five years).
  2. Required repayment within 60 days should the employee quit or be fired (or this will be seen as a withdrawal and the 10% penalty plus the income tax rate will apply).
  3. What is the rate for repayment? (Note: The rate is paying back yourself, not a bank or your employer.)
Mark’s 401(k) Katie’s TSP Katie’s IRA
Accessible Value $129,882.71 $8,198.23 $24,252.00
Maximum Loan $50,000 $4,099.12 N/A

Total for Down Payment: $50,000 + $4,099.12 = $54,099.12

401(k) Loan Option Plus Hardship Withdrawal (Without Penalty)

Should Katie and Mark need additional funds beyond the 401(k) loan options, they may also consider the hardship withdrawal. Some employer 401(k) plans require the individual to initially using the loan before using the hardship withdrawal.

Mark’s 401(k) Katie’s TSP Katie’s IRA
Accessible Value $129,882.71 $8,198.23 $24,252.00
Loan Amount $50,000 $4,099.12 N/A
Hardship Withdrawal N/A N/A $10,000
Remaining $79,882.71 $4,099.11 $14,252.00

Total from Mark’s 401k: $50,000
Total from Katie’s Retirement: $4,099.12 + $10,000.00 = $14,099.12

Total for Down Payment: $50,000 + $14,099.12 = $64,099.12

Conclusion

Mark and Katie need to weigh their options as far as the new monthly payment of the home mortgage plus the repayment to their 401(k). It may be more affordable to put up less of a down payment and consider mortgage insurance (or lender-paid mortgage insurance), but that is a whole other discussion. Each has different financial impacts and risks.

Even if Mark and Katie decide against taking funds from their retirement accounts, they are empowered with the knowledge of each outcome and can make the right decision for their growing family.

Should anyone find themselves weighing these options, I recommend speaking with your loan officer to consider the down payment percentages versus the monthly payment tied to each option. For example, a 10% down payment with mortgage insurance (or lender-paid mortgage insurance) may be a more realistic option than utilizing the retirement funds to achieve a 20% down payment.

If additional funds are needed, please collaborate with your CPA to determine the tax implications tied to each option. You can also talk to a certified financial planner to understand the impact that borrowing funds from your 401(k) will have on your future retirement plans.

After reviewing with your CPA or CFA, the next person in line is the retirement representative for your account to determine which documents are required and any limitations. Please realize the retirement representative may have the goal of keeping your funds within the 401(k), and you must come armed with the IRS knowledge of your rights for withdrawing your vested funds.

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8 Comments

  1. Are you sure your statement is correct re: hardship withdrawals from a 401(k) to purchase a primary residence? I thought they were subject to a 10% penalty.

  2. If I accept that I will need to pay 10% penalty and also income taxes, what is the best way to get my money out of my 401k? Can I roll it over to a Roth IRA then withdraw whatever I need (I don’t want to borrow, but withdraw with no obligation to repay)? Are there any rules or time limits barring this? The money would be used for a home purchase, but I have not had my Roth IRA for 5 years so the first time home buyer exception would not apply here.

  3. I cannot get the original purchase agreement from the owners attorney , my company sponsored 401K partner needs the original to process my hardship loan. What should I do to obtain this paperwork a copy will not work.

  4. I borrowed from my 401k once some years ago to pay college tuition for one of my kids. As I paid down the loan I reckoned this was a not so good deal. I took cash out of a tax deferred account losing any tax deferred gains while the loan was outstanding. I paid back my loan with after tax money deposited back into the tax deferred account. Now in retirement I am paying tax on my IRA withdrawals. So some portion of my withdrawals have been taxed twice by Uncle Sam.
    Check with your tax adviser whether your loan prepayment is a tax deduction which may make my caveat moot.

    1. IRAs don’t allow for loan options, BUT you are allowed to take a 10k Hardship withdrawal (one time) on a first time home purchase…avoiding the 10% penalty. You will still need to pay income taxes so you will want to keep that into account!

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