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Finding a Home Down Payment
When consumers are searching for ways to make a down payment on a home, one consideration is to withdraw funds from a 401(k) or other retirement plans. While on the surface this may seem like an ideal solution to down payment woes, before asking can I use my 401k to buy a house, understand the issues that are inherent to this type of down payment option.
Mortgage down payment seasoning
Nearly all mortgage lenders require a potential homeowner to show the "seasoning" of a home down payment. This means that the lender will often not accept funds that have not been sufficiently aged. In many cases (outside of specialized first time home-buyer programs), funds for the down payment must have been in control of the borrower for a period of not less than six months. Among other reasons, lenders feel that borrowers who are investing long term savings have less likelihood of defaulting on a mortgage. Additionally, this is to discourage "windfall" funds from being used for down payments.
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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 Generally speaking, most fund managers allow for up to fifty percent of vested amounts to be withdrawn, without penalty.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.
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Making the decision to buy a home is a major life-altering decision. It means that a conscious decision has been made to take on the full responsibilities of home ownership, including maintenance, taxes and a host of other challenges. When considering funds for a down payment, it is imperative that borrowers understand the advantages and disadvantages of borrowing from their 401(k) or other retirement plans.
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