Why You Shouldn't Borrow From Your 401(k) to Buy a Home

We all know saving for a down payment is no small task, and is often a journey too. You may even be getting excited when house hunting. If you do happen to find a home you absolutely have to have you better have the money to put down immediately. If you don’t have the money, you may be tempted to get it from your 401(k), but ignore this idea as it is a bad one! Don’t rationalize this and say you will pay yourself back; it will end up hurting you down the road.

If you can’t afford to buy a home without your 401(k), you can’t afford to buy a home. This is the biggest reason to avoid drawing from your 401(k). Not only does it take away from your retirement fund, but it’s a ton of added stress. Live within your means, and live like you should. Here are a few reasons to not touch your 401(k) when buying a house.

You will still need those savings down the road

Unlike an IRA withdrawal, you are forced to pay back any amount of money you take out of your company’s 401(k) plan. You could tell yourself that’s great because it’ll keep you honest with yourself. Not so fast, because if you lose or leave your job you could be forced to repay the amount in full within three months. You will also see a 10% fee (hardship withdrawal). If you didn’t have the money to begin with and borrowed from yourself, chances are you won’t have the money then either. Homes are expensive and they don’t just cost what the price tag says. Repairs, taxes, and unexpected troubles will cost you a pretty penny too.

A 401(k) loan can compromise your future wealth

The average 401(k) loan lets you borrow up to 50% of your balance, up to a max of $50,000. Let’s say you do take out the full $50,000, which is growing happily at 7%. If you borrow this in your 40’s, you would have grown that to $193,000 in 20 years. You are much closer to retiring now, but with less cash. The money you are paying yourself back with the last 20 years isn’t growing like it could have been. Keep on renting for now, and save for your future.

Penalized and taxed on early distributions

The IRS only allows certain 401(k) withdrawals without penalty, but buying a home isn’t one of them. Expect a 10% additional penalty because this income is now considered taxable income. Because your contributions are made with pretax money when you go to repay the loan, your payback will be made with after-tax dollars. Basically you are being double taxed.

Borrowing from your 401(k) can start a trend

Once you have done something it’s always easier to do it again. This is no different when it comes to money. People who don’t live within their means are used to this lifestyle and continue doing so down the road. People who are more conservative tend to live within their means. So don’t develop a pattern, it’s an ugly one you will wish you never began. 

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