Using Your 401(k) for a Home Purchase: Options & Rules

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If you lack enough money to cover the upfront costs of a home purchase, you might turn to your retirement funds. As an employer-sponsored retirement account, a 401(k) has specific rules regarding how you can access the money before you reach retirement age for this purpose. Depending on your plan and situation, you might be able to do a regular or hardship withdrawal without having to repay those funds, or you could borrow from the plan as a temporary solution for your home purchase. Weigh the pros and cons of these 401(k) options as well as consider other types of assistance for first-time homebuyers.

Taking a 401(k) Distribution

Your options for 401(k) distributions to fund a home purchase depend on your age and retirement plan rules. But in any case, these withdrawals are not tax-free since you'll at least pay your regular income tax rate on the amount taken. You also won't have the money growing in your retirement account anymore, though you can usually still make new contributions in the future to compensate.

If you've reached age ​59 1/2​, you can simply take a regular withdrawal and pay income taxes on the money. If you're younger and your employer allows the option, you can take a home purchase hardship distribution limited to the amount justified for the transaction. While there are exceptions for the penalty with other kinds of hardships like disability, the IRS makes you pay a ​10 percent​ early withdrawal penalty on top of the regular income tax amount for the money withdrawn to buy a home.

Note that the IRS rules differ from those for home purchase hardship withdrawals from traditional and Roth IRA accounts. When you use IRA funds for a primary residence purchase, you can get a penalty-free withdrawal of ​$10,000​ maximum.

Borrowing From the 401(k)

If you check your retirement savings plan documents, you'll often find your employer will let you ask for a 401(k) loan. The amount available to borrow will be the lesser of ​$50,000​ or ​half​ your vested account balance. Depending on your vested balance, the loan could cover your down payment and closing costs.

This option has benefits over a withdrawal since you'll end up putting the money back in your 401(k) to grow for your retirement. You won't need to have a specific credit score or have your debt-to-income ratio checked either. However, you'll want to ask about the interest rate for the loan and consider the total costs to determine whether it suits you financially.

Depending on your plan and situation, you might be able to do a regular or hardship withdrawal without having to repay those funds, or you could borrow from the plan as a temporary solution for your home purchase.

As long as you're borrowing to obtain a primary residence, you can expect to have ​five years or longer​ to repay the principal and interest for the 401(k) loan; otherwise, loans have a maximum ​five-year​ repayment period. However, you may find yourself having to pay up early if you lose or quit your job before the repayment period is completed. Also, you can face income tax penalties where the IRS considers your 401(k) loan a withdrawal if you fail to follow the terms.

Considering Alternatives for Home Purchase

Keep in mind that using money from your 401(k) retirement account tends to have disadvantages both now and later. So, consider seeking other options for getting enough money or lowering the upfront costs to become a homeowner.

For example, you can ask a lender about home loan options with a low down payment such as an FHA loan, VA loan and some conventional mortgage loan programs. Down payment assistance programs for a first-time home purchase can include grants or loans covering your down payment and closing costs.

You might turn to other sources like asking your family for a down payment gift, using what you have in your savings account or withdrawing from other tax-advantaged accounts like an IRA. Working with a financial advisor can help you save toward homeownership as well.