Issues using 401(k) Withdrawals for Down Payments
In addition to the seasoning requirement that many lenders require, there are other considerations that must be examined when a homeowner asks the question can I use my 401k to buy a house. While the simple answer is that it may be done, there are ramifications to this method of obtaining a down payment. They include:
Penalties and taxes: The Internal Revenue Service allows for certain hardship payments from 401(k) plans. Home down payments can be claimed as a hardship. What this does not prevent, however, is the penalties and taxes that are associated with a hardship withdrawal. Should a consumer elect for a hardship withdrawal, these funds also cannot be re-deposited in a 401(k), meaning not only can the potential homeowner be losing principal; they are paying heavy amounts of their funds on penalties and taxes.
401(k) loans: A secondary option for the potential homeowner is requesting a loan from a 401(k) balances. Generally speaking, most fund managers allow for up to fifty percent of vested amounts to be withdrawn, without penalty. However, these amounts need to be repaid to the plan. The issues that are inherent in this include:
- Losing a job - should the company decide to lay off the employee, there may be a call on the 401(k) loan. In this instance, if the loan were not paid back within the specified period of time (typically sixty days), then the loan would convert to a withdrawal resulting in penalties and taxes. The same would be applicable if the homeowner were to change jobs.
- Debt to income ratios - since most lenders are using a debt to income ratio, some homeowners may not be qualified for a mortgage loan if they are using borrowed funds from a 401(k) plan. The difference in the loan amount could result in changing debt ratios in a significant enough manner to disqualify them.
Loss of capital and interest: Another reason a potential homeowner may want to consider alternatives before taking money from a 401(k) for a home down payment is the loss of capital and interest. Since a 401(k) is meant to be a retirement account, this could have long term consequences.