Can I use a 401(k) to buy a house?

You’ve been crunching the numbers to afford the down payment on a house, and then it hits you—there’s a nice chunk of money sitting in your 401(k). Retirement is a long way off and you could use the money right now to become a homeowner. Is it worth it to tap that cash reserve?
A 401(k) is a retirement savings account. These accounts earn money as they grow, hopefully leaving you with a sizable sum when it’s time to retire. But what if you want to access that money early? Technically, it’s possible. But the financial penalties for early access can outweigh the benefits.

Here’s everything you need to know before dipping into your 401(k) to help purchase a home.

Can I use a 401(k) to buy a house?

If you have a 401(k), then you already know it’s a type of retirement savings account sponsored by your employer. Over time, you contribute a predetermined amount from each paycheck, and your employer may even match some of your contributions to help fund the account.

Your 401(k) account can be a powerful tool when it comes to financial goal-setting and retirement planning. Not only do the funds in this account earn money over time, this type of savings account comes with some key tax advantages—namely, contributions you make into a 401(k) come from your gross income as an employee.

In other words, your money can grow tax-free. And because taxes haven’t been taken out of this money yet, the entire sum of your contributions can be written off to reduce your total taxable income at the end of the year. You don’t have to pay taxes on the money you put into a 401(k) or the earnings that accrue in that account until you withdraw it later in life.

For many people, a 401(k) account contains the largest percentage of their total savings portfolio. If that’s the case for you, it might be tempting to put that money toward a worthwhile purchase—like buying a new home.

While it is technically possible to make an early withdrawal and put money from your 401(k) toward your home purchase, there are also some serious downsides to this tactic.

Short-term consequences of early 401(k) withdrawal

Because 401(k)s are intended for retirement, money withdrawn before the age of 59½ (or 55 if you leave or lose your job before then) is typically subject to a 10% early withdrawal penalty fee. Yikes. Once you remove those funds from your 401(k), they’re also no longer protected under the tax-free shields of the account and are immediately subject to income tax. Double yikes.

These penalties can be particularly hefty if you have a significant amount in your 401(k). Beyond that, you also have to consider the future wealth losses you’ll incur by removing money from a high-earning account.

Long-term consequences of early 401(k) withdrawal

If the 10% early withdrawal penalties don’t give you pause, keep in mind that there are long-term consequences to crippling your retirement savings. By taking that money out, you’ll be jeopardizing years of growth that you can never truly recover. While you can pay back the money to your account, you can’t get back the account earnings lost during that time.

When a 401(k) withdrawal might make sense

Despite the downsides, some homebuyers may decide that the benefits of early 401(k) withdrawal outweigh the risks. If you choose to leverage funds from your retirement savings to help afford a home, you may qualify for a “hardship withdrawal” status. This means you could access your money penalty-free and avoid the 10% fee (particularly if you’re purchasing a primary residence.) While penalty-free access means you save a nice amount when accessing your funds, a hardship withdrawal can never be repaid into your 401(k)—you would be forfeiting that amount from your retirement savings altogether.

According to the IRS, a hardship withdrawal exemption must be proven to be used for an immediate and heavy financial need. Costs directly related to the purchase of a principal residence (excluding mortgage payments) are sometimes considered an allowable exemption.

You may only withdraw the amount necessary to satisfy the immediate need and if you have any other assets that could technically be put toward a down payment, you’re unlikely to be approved for hardship exemption. Even if your withdrawal does qualify for exemption status , you’ll still face income tax on the total amount withdrawn.

Are there other 401(k) options?

Withdrawal is not the only way to access 401(k) funds for a down payment.

Your benefits provider may also offer 401(k) loan options. If available, this option not only helps you avoid the early withdrawal penalty fee, but also paying income tax on your withdrawal.

401(k) loans let you borrow up to 50% of your vested account balance (up to a maximum of $50,000.) Taking out this type of loan puts your 401(k) account on hold for the duration of the loan — you won’t be able to make additional contributions until the money is paid back.

But how can you calculate whether the 401(k) loan is a smart financial decision? As with any lending scenario, the price you pay to borrow the money has a big impact on determining whether the loan is worth it. You can typically expect a 1%-2% spike above the prime rate for these types of loans. Another factor to consider has to do with your employment. If you’re unable to pay back the loan on time or before leaving/losing your job, you may be subject to the same financial penalties that come with a withdrawal.

Is buying a house with your 401(k) a good idea?

Coming up with the money to afford a down payment on a house can be challenging for some borrowers. While using cash from your 401(k) to cover the upfront costs of homebuying is technically possible, it’s not always the best option available. Before starting the withdrawal process, you might want to investigate other loan options with more flexible down payment alternatives. . Some mortgage loans allow you to put as little as 3% of the home’s purchase price down.

If you know you’re ready to start the homebuying process, see what rates you qualify for and get pre-approved to understand your options. At Better Mortgage, you can get pre-approved in as little as 3 minutes.