Borrowing money from 401k...how does this work usually?

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Theoretically, if someone were to "borrow" from their 401k for a first-time home purchase, how does that work?

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Depends on your 401k plan. You'll have to look at the documents.

If your plan allows it you can borrow up to a certain amount / percentage of your balance. After you apply and are approved (shouldn't be difficult) you get a distribution of the loan amount that must be paid back in installments within a certain period of time. The interest rate is usually not that high and shouldn't matter to you too much because you are paying yourself the interest back (the loan is from yourself after all). In the end you will just be paying the loan amount plus interest back to your 401k (minus any loan maintenance fees, which should be minimal - check your plan for this).

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Is this a terrible, terrible crippling financial idea? Or is this a viable way to get a down-payment on short notice?

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It's not necessarily a bad idea, but it has potential pitfalls. Things to consider:

-You will miss any potential returns on the money that you would otherwise have gotten if they stayed invested. If the market shoots up in the time you have the loan out, you lose. Compounding is your best friend in retirement saving and this will set you back a bit in that regard. Of course if the market tanks during the time you have the loan out, you actually could benefit.

-If you don't/can't pay the loan back, it could be considered an early distribution which would suck bad for your taxes and you would be penalized on top of the tax burden. Don't default.

-Related to the default, check your plan to see what happens if you lose/leave your job. Will the loan become payable in full immediately or will you still be able to pay it back according to the original installment terms? Having to pay it back immediately upon change of employment (or else it will be considered a default and early distribution) could be bad.

With that said, there are situations I think taking a 401k loan to buy a house could be okay to do. Most will tell you to just save and wait, but there could conceivably be circumstances where it makes sense to buy the house now rather than wait.

I have a question about the loans as well


Do your payroll deductions and employer match go towards the loan balance first or are they kept completely separate from the loan repayment?

Saved me from typing all of that. I agree whole-heartedly.

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Just the way you are describing your financial situation, difficulty to endure 5k in extra expenses over a year's time, etc., I'd be worried about jumping into home ownership right now. That shite has so many expenses you don't realize, it could put you in a bad situation. It's nothing for 10k of crap to go wrong in your house in a year. Sounds like you need more liquid savings before owning a home to be honest. Not saying a 401k loan is always a bad idea, but the hidden costs of homeownership can kill you if you have depleted your savings just to buy the thing.

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Fair.

Thanks for the advice.

FTR, I could pay back the 5k in a few months if I wanted to if that makes a difference. Just would rather have more money in my account on a regular basis.

I need to talk to my 401k people to see what the loan period is and what kind of rates they have.


ETA:

I'm also lucky in the fact we both have families who would be willing to help in the event of a financial issue. I just want to avoid asking for a down payment. Really wanted this house to be "ours" for some reason.

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I'm also lucky in the fact we both have families who would be willing to help in the event of a financial issue. I just want to avoid asking for a down payment. Really wanted this house to be "ours" for some reason.

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If they would pitch in for a down payment, you could always take the "loan" from them.

They put down whatever you need, you just set up an auto bank account transfer to their checking account on whatever terms you come to. I'm sure they'll even give you 0% interest if they were going to give you the money anyways.

That way you avoid all the negatives, and still get to call it your own.

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No problem. I speak from experience. We stretched for our first house and were surprised at how much money we put into it the first year. We made plenty of money according to all the charts for how much home you can afford, easily qualified for way more than our mortgage, etc. but we were cash poor and depleted savings to buy the house. Only time in my life I carried credit card debt from month to month. Hated it.

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this! Don't listen to the realtor or mortgage broker on how much you can afford. Do a budget and give yourself a ton of wiggle room.

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They'll look at his bank statements when he applies for the loan. If he suddenly has a few thousand unexplainable dollars show up, then it won't be applicable to the mortgage unless he applies for an FHA loan. I believe it is the only loan program allowing gifts (or "loans") to be used as a down payment.

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That's not true.

ETA: They will ask him to fill out a gifting document that his parents will have to sign stating there are no contractual rights to the gifted monies, ie that its a true gift and they don't have any legal right to repayment.

If this is an "investment" and not your primary residence you going to be looking at 15-25% down not 3.5%

Also is your 401k pretax or Roth?

If its pretax your withdrawal is going to be taxed heavily.

My tax guy was telling me one of his clients pulled out 100k to build a pool and a pool house. When tax time came he owed Uncle Sam 30k

It's not the worst way to borrow money to get into a house. But as others have cautioned, you may be stretching yourself thin if something unexpected happens. With that said, apart from the federal rules that govern them, the only way to know how your plan works is to read the plan docs. Under three different employers, I've had three different plans, although I've only taken a 401k loan once in my life (as a way to do something financially odd that paid off by luck). Some allow the interest on the loan to go back into the account - so you're basically paying yourself. With some plans, you're selling shares to raise funds. With others, you're not. The loan repayments tend to be separate from the employer and employee contributions... but read your plan docs.

If you happen to leave or get laid off while you still have a balance, you'll have a certain period of time to pay the loan off before you're penalized.

Good luck with the first time home purchase.