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Borrowing money from 401k...how does this work usually?
Posted on 2/23/16 at 4:15 pm
Posted on 2/23/16 at 4:15 pm
Theoretically, if someone were to "borrow" from their 401k for a first-time home purchase, how does that work?
Theoretically, this person has plenty of money in the 401k for the age of 28 (like 50kish), but little in traditional savings and wants to buy a home. This person makes plenty to afford a mortgage they are aiming for and just got married.
These people want a certain house that would be a great investment but don't have the down payment at the moment due to other recent expenses.
Do they have horrible loan rates? Is this a terrible, terrible crippling financial idea? Or is this a viable way to get a down-payment on short notice?
Theoretically, this person has plenty of money in the 401k for the age of 28 (like 50kish), but little in traditional savings and wants to buy a home. This person makes plenty to afford a mortgage they are aiming for and just got married.
These people want a certain house that would be a great investment but don't have the down payment at the moment due to other recent expenses.
Do they have horrible loan rates? Is this a terrible, terrible crippling financial idea? Or is this a viable way to get a down-payment on short notice?
3
Posted on 2/23/16 at 4:24 pm to TheCaterpillar
A couple questions...
Do you not have enough to cover the 3.5% down payment for an FHA loan or not enough for a 20% down payment to avoid PMI?
Also, how long will it take you to pay back the 401k loan?
Do you not have enough to cover the 3.5% down payment for an FHA loan or not enough for a 20% down payment to avoid PMI?
Also, how long will it take you to pay back the 401k loan?
Posted on 2/23/16 at 4:27 pm to TheCaterpillar
quote:
Theoretically, if someone were to "borrow" from their 401k for a first-time home purchase, how does that work?
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).
quote:
Is this a terrible, terrible crippling financial idea? Or is this a viable way to get a down-payment on short notice?
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.
Posted on 2/23/16 at 8:21 pm to TheCaterpillar
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.
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.
This post was edited on 2/23/16 at 8:25 pm
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