Should You Borrow From Your 401(k) to Buy a House? Pros & Cons

I see this all the time.

A buyer finds the house they really want, but they need more money for the down payment. They have some savings…and then they remember the money sitting in their 401(k).

The next question is usually:

“Should I use my 401(k) to buy the house?”

And sometimes:

“Why not take even more out, make a bigger down payment, and have a smaller mortgage?”

I understand the thinking. But before touching retirement money, I want buyers to look at the long-term numbers, not just the mortgage payment.

Borrowing vs. Withdrawing From Your 401(k)

There is a BIG difference between borrowing from your 401(k) and withdrawing the money permanently.

If your employer's plan allows 401(k) loans, you may generally be able to borrow up to the lesser of $50,000 or 50% of your vested balance, although your specific plan determines what is actually available.

You then repay the loan through your paycheck.

One interesting part? The interest you pay generally goes back into your own 401(k) account.

So you're borrowing from yourself and paying yourself back.

That doesn't mean it's free money. While the money is borrowed, it isn't invested in the market, so you could miss potential investment growth. You also have another monthly payment coming out of your paycheck.

But compare that with simply taking the money out.

What Happens If You Withdraw the Money?

If you're under 59½ and take an early taxable distribution from a traditional 401(k), you could owe:

• Federal income taxes

• A possible 10% federal early-withdrawal tax

• California income taxes

• A possible additional 2.5% California early-distribution tax

There are exceptions, so this is definitely a conversation to have with your CPA or tax professional.

And here's something many first-time buyers don't realize:

The IRS has a first-time-homebuyer exception for certain IRA withdrawals, but that particular exception doesn't generally apply to a 401(k).

Let's Look at $40,000

Let's say you're buying an $800,000 home and need $40,000 for a 5% down payment.

Option #1: Borrow $40,000 From Your 401(k)

For illustration, let's say the loan is:

$40,000 at 7.75% for five years

The payment would be approximately $806 per month.

That's certainly an expense we need to include in your budget.

But you're paying the principal back into your retirement account, and the interest generally goes back into your account as well.

Option #2: Withdraw $40,000

Now let's assume, strictly as an example, you're in the 22% federal tax bracket and also owe the 10% federal early-withdrawal tax.

Potential federal cost:

$8,800 income tax + $4,000 early-withdrawal tax = $12,800

That could leave you with only about $27,200 from the original $40,000 — and that's before California taxes.

Ouch.

But Here's the Number I Really Want Buyers to See

What could that $40,000 potentially become if you simply left it invested?

Using a hypothetical average return of 8% per year for 25 years:

$40,000 could grow to approximately $274,000.

Of course, investment returns are never guaranteed.

But that's why I don't look at taking $40,000 from a retirement account as simply spending $40,000.

You're also potentially giving up years of compounded growth.

Is a 401(k) Loan a Good Idea for Buying a House?

Sometimes it can be.

But my first question is actually:

Do we need to touch the 401(k) at all?

Maybe you don't need the larger down payment.

Maybe keeping more money invested makes better long-term sense.

Maybe having healthy cash reserves after closing is more important than squeezing your mortgage payment as low as possible.

But if the choice is between permanently withdrawing $40,000 or borrowing $40,000 and paying it back, I would generally want my buyer to investigate the loan option first.

There are still risks. You can miss investment growth while the money is borrowed. Your take-home paycheck will be smaller during repayment. And depending on your plan and circumstances, leaving your employer or failing to repay the loan properly could create tax consequences.

Don't Sacrifice Tomorrow Just to Lower Today's Mortgage Payment

A bigger down payment isn't automatically the smartest financial decision.

Your mortgage is only one piece of your financial life. Your savings, emergency reserves, retirement account, taxes and long-term goals matter too.

Sometimes 401(k) money can absolutely help someone become a homeowner. The key is using it strategically instead of automatically.

Before taking money out of your retirement account, find out whether your plan allows a 401(k) loan. Then talk with your lender, financial advisor and tax professional and compare the numbers.

Buying the house is important. But so is having money when you're ready to retire.

Thinking about buying a home and wondering how much you really need for the down payment? Reach out to me. We can look at your options before you start moving money around and determine what makes the most sense for your home purchase and your overall financial picture.

Mariness Chata
RE/MAX of Santa Clarita
661-317-3332
RealtorMariness@gmail.com

This information is for general educational purposes and is not tax, investment, financial or legal advice. 401(k) rules and individual tax situations vary. Consult your plan administrator and appropriate financial and tax professionals before making a decision.